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Banking Concepts: Reasons & Impact of Falling Rupee
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With USD-Rupee touching all time low and making daily news
headlines, we are sharing an extremely
useful article for understanding the Reasons for falling Rupee
and its impact. Article was featured in
Times of India. Points from this article will also be helpful in
Interviews.
# Why is rupee weakening against the dollar?
There are several factors. But the recent bout of weakness is
fueled by the prospect of the unwinding of
the bond purchase program of the US Federal Reserve.
The US Fed had been printing money to bolster its economy. Now
that there are signs of some strengthin the US economy, it may
start winding down the program of adding more money into the
system.
A possible winding down of the asset purchase program of the US
Fed and improvement in the health of
the US economy will strengthen the US dollar. Investors will
withdraw investments from emerging
markets such as India in the short term and chase assets in the
US, since assets in a strengthening US
economy are seen as attractive. The outflow of money from
emerging markets may lead to currency
weakness. Concerns over the pace of economic reforms, the health
of the domestic economy and a
yawning trade deficit are also impacting the rupee.
# How will weaker rupee hurt the economy?
A weak currency will make imports more expensive. Normally,
theory suggests this should lead to a
curtailing of imports. However, given the fact that some of
India s major import items, like crude oil, are
immune to price changes, the theory does not quite apply in this
case.
# What is current account deficit (CAD)?
The CAD is effectively a measure of the amount of net capital
inflows from abroad that an economy
depends on, whether in the form of borrowings or investment.
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# What impacts widening of CAD?
Two factors have been blamed for widening of CAD. One is the
import of gold. India is one of the largest
consumers of gold and the heavy import of gold widens CAD as the
government has to provide for
dollars for every ounce of gold imported. The other factor is
crude oil imports. India imports more than
75% of its crude oil requirement. A slowdown in inflows from
foreign investors also leads to a weak
currency. At a time when the rupee is depreciating, foreign
portfolio investors are wary of investing in
India since any rupee income they earn could get eroded by a
higher exchange rate when they want to
take back that income out of India. Thus, a sort of vicious
cycle is triggered as the rupee dips, FIIs tend to
pull out money and that in turn makes the rupee dip further.
This can be offset by boosting longer term
capital flows from abroad like FDI or overseas borrowings.
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ADMIN : Subhash Kumar
