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GA Topper Series : Rupee vs Dollar Exchange Rate

Recent in News: The exchange rate of the Indian Rupee against the US Dollar as on 30 June of the last five years was shared in the parliament.

Date INR/US$
29.06.2018 68.5753
28.06.2019 68.918
30.06.2020 75.527
30.06.2021 74.3456
30.06.2022 78.9421

On 25th July 2022, Rupee crossed 80rs mark. So what are the reasons for the depreciation of the rupee with respect of US Dollar?

  1. US-China trade war in 2018
  2. A rate hike by the US Federal Reserve in 2018
  3. COVID-Related Disruptions in 2020
  4. In Present, the Russia-Ukraine conflict, soaring crude oil prices, and tightening of global financial conditions.

These reasons were shared by the finance minister in parliament.

Lets us first define what an exchange rate is and how it is determined in India.

Foreign Exchange Rate is defined as the price of the domestic currency with respect to another currency. The purpose of foreign exchange is to compare one currency with another for showing their relative values.

In India, the exchange rate of the Indian Rupee is market determined. But it is managed by the RBI in times of need.

Now understand how the above reasons affected the exchange rate.

  1. As global tensions rise as a result of the US-China trade war and the Russia-Ukraine conflict, global investors withdraw their funds from developing countries and park them in more stable developed economies. This led to a huge demand for dollars in the market. As the demand for dollars increases, the rupee depreciates.
  2. During the COVID pandemic, the supply chain of exports was broken, which affected the exchange rate.
  3. The interest rate hike by the US Federal Bank makes loans costlier. These loans are actually used as investments in developing countries like India. This is because India gives a higher interest rate on its investments. But as the loan got costlier, it reduced the investment and dollars in the market.
  4. Tightening global financial conditions occur when central banks of countries raise interest rates in order to control inflation in their countries. This leads to a reduction in investments.

What is the effect of the depreciation of the rupee on India’s economy?

  1. As money flows out of India, the rupee-dollar exchange rate gets impacted, depreciating the rupee. Such depreciation puts considerable pressure on the already high import prices of crude and raw materials, paving the path for higher imported inflation and production costs besides higher retail inflation.
  2. A weakening domestic currency boosts exports as shipments get more competitive and foreign buyers gain more purchasing power.
  3. It affects the forex reserves of RBI. We have seen a decrease in forex reserves in recent months.

Expected Questions:

  1. Under which act, forex reserves are managed by RBI?
  2. What is the opposite of depreciation?

Write your answers in the comment section below. You can write to us about any topic you want to see covered in an article. 

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