The Indian Rupee struggles to recover after falling below 76.00 against the U.S. Dollar amid the COVID-19 economic breakdown. Investors pulled out their investments, dumping most of the emerging market holdings, and opted for maximum liquidity to cater to immediate financial needs. At present, the Indian Rupee (INR) hovers around 72.94 against the U.S. Dollar. The INR tested its all-time low level of 75.00 in 2020. According to an average estimate, the INR has depreciated by more than 5%, with a major fall recorded in March 2020.
Why is the Indian Rupee so weak against the U.S. Dollar?
Just like the Global Financial Crisis (GFC) back in 2008, the COVID -19 outbreak triggered extensive economic uncertainty worldwide. As a result, businesses and individual investors took a step back, liquidating their assets into cash, specifically the U.S. Dollars.
After foreign investors dumped their stake in Indian equities and debt securities, the Indian Rupee deteriorated significantly. The Indian Rupee didn’t fall to such lows even in 2013 when the U.S. announced the quantitative easing programs to strengthen the U.S. Dollar in the emerging markets.
Foreign investors sold their holdings in the bonds and shares market of India in March 2020. As an average estimate, sale proceeds valued over 12 Billion U.S. Dollars. The outflow resulted in a sharp decrease in the equity markets. The stock market slumped by 22% in March 2020.
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What else contributes to the fall of the Indian Rupee (INR)?
The decline of the Indian Rupee against the U.S. Dollar accompanies the global trend in which a majority of foreign currencies fell against the USD. The risk-averse approach of investors amid safety against the COVID-19 pandemic was so outrageous that it didn’t spare the U.S. treasuries and gold that are generally considered to be the safe havens for investment. Investors didn’t refrain from liquidating their holdings in gold and treasury bills.
Some more reasons behind the depreciation of the Indian rupee against the U.S. Dollar are listed below:
Crude Oil Imports
India is only capable of producing up to 20% of crude oil to meet its domestic needs. Therefore, it imports the rest of crude oil from countries like Saudi Arabia, Iran, Iraq, and some gulf countries. As a result, the country needs to make huge payments on account of crude oil import bills. The country is still witnessing an increased demand for crude oil. That means there will be more outflow of USD to settle down the import bill liabilities. Hence, the increase in demand automatically devalues the Indian currency against the U.S. Dollar.
The trade war between the US and China
The former president of the United States, Donald Trump, started a trade war with China back in 2018. China and its neighboring countries, including India, retaliated against it. As a result of the trade war, the prices of imported commodities soared further, leaving the affected countries to undergo more outflow of U.S. Dollars.
Increasing Trade Deficit of India
Whenever a country observes exceeding import levels as compared to its exports, the cost of import results in a trade deficit. India recorded a trade deficit of nearly 157 Billion U.S. Dollars in 2017-18. It is also the widest trade deficit over the past five years. As an estimate, the Indian trade deficit for January 2021 is 14.54 Billion U.S. Dollars. Therefore, one of the main reasons for the weakened Indian Rupee is the Indian trade deficit that accompanies USD cash outflow.
Foreign Currency Outflow
It is worth mentioning here that whenever foreign investors find better investment opportunities in the rest of the world, they liquidate their stake in the national stock and equity market. The cash outflow of the U.S.Dollars makes the market fall for the Indian Rupee.
It also triggers the risk of inflation amid domestic currency depreciation. As a result, the RBI also raises interest rates that even further reduces the purchasing power of the Indian Rupee. Not to mention, the already slower credit growth also dips further by the decrease in the value of local currency.
Should the price continue to fall, the cost of hedging currency risk will increase amid rising global interest rates. Hence it might become more challenging for India to bear the cost of external borrowings in the coming months. The weakened economic activities might dampen corporate borrowings and could become a source of trouble for India in times of need.