Rupee Depreciation- Why is it depreciating? Describe the impact on India’s Macroeconomics.
The depreciation of rupee against the dollar is not a recent phenomenon. If we see the valuation of rupee over the past six decades, i.e., post-independence, we can see a continuous downward trend. Though there have been temporary fluctuations in the value, the general trend has been negative. To find the root cause of this phenomenon we need to go 200 years back. Prior to the 18th century most of the economies around the world followed the Silver standard. But then these economies switched to the gold standard, due to the devaluation of Silver as the supply of Silver increased due to increased mining activities. But the British rulers of India did not allow the Indian currency to switch to the gold standard. This resulted in a structural weakness of the currency, which we can still feel to this day. Another landmark episode in the depreciation of the rupee was the 1991 liberalization reforms. Post the reforms the rupee was devalued and allowed to float against the dollar to make Indian exports competitive and shore up more dollars into our reserves. Although we have reaped the benefits of this devaluation for long, the current depreciation is hurting the economy. Now moving on to the recent volatilities in the valuation of rupee, we can see the cause can be attributed to a number of policies and events occurring onshore as well as around the globe. The first would be the strengthening dollar. As the US economy improves, US Treasury bonds yield is increasing and the arbitrage advantage that India had is diminishing. Investors are pulling money out of Indian markets and investing back home in dollar backed bonds, hence increasing the demand for Dollars. This ends up strengthening the dollar against the rupee. Secondly we need to look at the foreign currency reserves that