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What Causes The Indian Rupee To Fluctuate?

September 5th, 2019

What causes the Indian rupee to fluctuate?

Traditionally, India has compared its national currency with the US dollar to gauge its financial health. The fact that the Indian National Rupee (INR) stood almost at par with the US Dollar (USD) at the time of the nation’s independence might sound more like a fairy tale to us today.

Coincidentally, 72 years later, the Indian rupee is hovering around 72 per USD. Speaking of USD to INR exchange rates, in the calendar year 2018 the Indian rupee slid from around 63 per USD to 74 per USD before recovering to around 69 by the end of the year.

How the rupee got to where it is today?

How did the Indian currency slide so drastically against the US dollar in the past seven decades? One doesn’t have to delve into history for explanations; the answer to this question can be found in the recent performance of the Indian rupee.

To begin with, the US dollar has been strengthening consistently in recent times and there has been a strong demand for the dollar among importers and banks. As a result, most Asian currencies are struggling against the dollar, including the Indian rupee.

The dollar also strengthened because of the consistent interest rate hike by the US Federal Reserve. These hikes make the US dollar more attractive in the global market, as other emerging economies struggle to keep up with the world’s primary reserve currency.

Due to the volatile economy of India, there has been a stagnancy in the market and low demand is pulling down the growth numbers as well as the Indian currency. Foreign players have been withdrawing from the Indian equity market and large outflows have contributed to the fall of the Indian rupee.

The ongoing US-China trade situation seems to be having a domino effect on global trade, which is affecting the Indian currency. The Indian rupee has suffered whenever crude oil prices rose, because of India’s massive crude oil import bill. The widening trade deficit has also immensely contributed to the rupee’s constant decline.

Effects on inward remittance

The weakening of the Indian rupee is followed almost immediately by a spike in inward remittances to India. Major outflow centres like the UAE and the US saw an increase in remittances as AED to INR and USD to INR exchange rates fell. After last year’s free fall, inward remittance to India increased by 25 percent, as Indian expats capitalised on the increased value they got against other currencies.

Read also: What is the best method to send money to India?

Trade and other trends vis-à-vis the Indian rupee

When exchange rates fluctuate, be it AED to INR or USD to INR, and the Indian rupee falls, it’s not all doom and gloom for the local economy. As imports become expensive and exports become more affordable, a weakened domestic currency can actually be a stimulus to the country’s trade deficit.

This, however, may not particularly benefit India at this point as its foreign trade is linked closely to the global value chain. The country exports jewellery made from precious stones – which are imported. The same would apply to India’s steel, automobile, engineering, and electronics exports.

We already considered the effect of global trade trends on the Indian currency in the context of the US-China trade situation. With US President Donald Trump imposing 15% tariff on a variety of Chinese goods, the two giants can potentially drift further apart.

The propensity of the Indian rupee to follow the Chinese yuan is becoming more evident as it falls every time the CNY weakens against the USD. Then there are one-off events that take its toll on currencies; last year, it was the Turkish currency crisis that affected emerging economies (including the BRICS nations).

While the Indian rupee’s slide last year was quite noticeable, as recently as August 2019 it was again the worst performing Asian currency. The trade war and international oil prices, demand stagnation, liquidity outflow, and widening domestic trade deficit all seem to have put the Indian currency into a downward spiral, leaving a burgeoning fear in the immediate future.