Falling Rupee Effect on Inflation

Falling Rupee Effect on Inflation in India

Rupee Falling Against The Dollar

• Indian rupee has fallen more than 11 percent against the US dollar so far in 2022.
• Previously, to determine the value of currency, purchasing power parity theory was used.
  • According to which, external value of a currency is determined by its internal value i.e rate differential between one currency and another depends upon the difference in the inflation in the two countries.
  • It was during a time when the balance of payments of a country was dominated by current account (export and import of goods and services).
• Currently, both Current and capital account dominate balance of payments.
  • Thus, value of a currency can be strong despite the fact that it has a high current account deficit because there is enough capital flowing from outside into the country.

Falling Rupee Effect on Inflation in India

Reason for Rupee Falling Against the Dollar

• Declining Inflow of Funds: US Central bank (Fed), with a view to control inflation in the United States, has raised the rate of interest.
  • Therefore, investors find that the United States is more attractive and stable in current global turmoil.
  • Instead of sending funds outside, they are keeping the funds inside.
  • Also, investors are withdrawing the funds from India and investing them in the United States.
• Increasing cost of petroleum: The rising cost of petroleum has forced Indian authorities to sell rupee and buy dollars for the purpose of payment. This has also depreciated rupee value vis-a-vis US dollar.

Falling Rupee Impact on India

• Diminish Value of Rupee: Rupee Depreciation reduces the value of a country’s currency when compared with the currency of other countries.
  • Depreciation discourages imports because the imported goods become more expensive due to a reduction in the value of rupee.
  • As the goods become more and more expensive it leads to rising inflation.
• Imported Inflation: A falling rupee puts pressure on the import prices of crude and raw materials, resulting in higher imported inflation.
• Export-led boost to the domestic economy: Devaluation or the depreciation in the value of the domestic currency may be advantageous because an undervalued currency is more attractive for exports.
  • Thus, industries linked to exports like pharma and IT benefit with depreciation.
• Unhealthy for Net Importing Country: Steep deterioration of currency is not healthy in long term, as India is still net importer of commodity i.e industries linked to imports have to bear higher input cost.
• Spurious Cycle: A weaker rupee can discourage Foreign portfolio investment (FPIs).
  • In turn, FPI outflows can further push the rupee to depreciate.

Way Forward

• Reduce our inflation rate Gap: US talks of 2% as the appropriate inflation, whereas, India talks of 4% as the appropriate inflation.
• Need to control inflation: RBI has raised the rate of interest to:
  • Moderate inflation.
  • It does have an effect in terms of the value of the rupee as well.

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