The rupee has been plunging in value for quite sometime now. On June 28, it depreciated to a lifetime low of 69.04 against the US dollar. The depreciation is largely against the rising dollar which gains significance as much of India’s trade and foreign debt is denominated in dollars.
Strong month-end dollar demand, along with a rise in crude oil prices, continued to hamper the Indian rupee. A sustained outflow of foreign funds also added pressure on the rupee as per the currency analysts. Periodic bouts of currency depreciation are a symptom of India being a bubble economy that can burst any time.
Post reforms India transformed into a favoured destination for international financial investors resulting into large capital inflows which define the bubble on which Indian economy rides. The retreat of these financial investors due to rising interest rates in the advanced countries along with net current account deficit on India’s balance of payments is one of the proximate determinants of the rupee’s decline. When the interest rate rises, new flow of investments is restricted; this not only affects equity and debt market, but also weakens the rupee due to increased demand of deficit foreign capital.
The decline has further been intensified by the sharp rise in the international price of oil. Every country needs foreign currency to finance its needs and must borrow to meet them making it difficult to sustain the value of its currency. Till now, the low oil prices had kept low the outflows on account of imports of goods but with changing oil prices, the pressure on the rupee is high.
Currency depreciation increases the cost of our imports and also increases the cost of servicing our foreign debt. When rupee depreciate, it enhances pre-existing economic vulnerabilities such as inflation. Further, as one of the factors underlying depreciation is an increase in oil prices, the potential for inflation is much higher. Inflation forces RBI to withdraw cheap money policies creating shortage of low-interest capital, thus pushing the economy further into an envelope of stagflation.
India’s difficulty in attracting foreign currency flows is exacerbated by poor bond market, unclear policy communication by the Reserve Bank of India and rising political risks ahead of the 2019 elections. Depending on the intensity of these effects and causes, the bubble of Indian economy unless scrutinize can become unsustainable, ready to burst at any time.