Why does Indian Rupee fall against US Dollar?

The Indian Rupee is close to making new lows versus the US dollar. And to be fair, this is not something new. Every now and then, there are news items about how INR is depreciating and USD is appreciating.

In fact, have a look at the 10-year data of USD-INR exchange rate below –

Related Reading – Exchange rate history of Indian Rupee

It is clear that in general, the value of 1 US Dollar versus Indian Rupee keeps on going up. There are periods of volatility every now and then but in general, the trend is clear.

So why does this happen?

Why does the Indian Rupee generally keep falling against the US Dollar?

It is a little complex with multiple factors at play. But let me try to explain.

The value of any currency is determined by supply and demand. If there is more demand for a currency than there is supply, the value of that currency will increase. Conversely, if there is more supply of a currency than there is demand, the value of that currency will decrease.

The value of the Indian Rupee against the US dollar also works on the same principle of supply and demand (at most times).

When the demand for the US dollar increases, the Indian Rupee depreciates and vice versa. When a country imports more than it exports, the demand for dollars exceeds the supply and local currencies such as the Indian Rupee.

And India has always been a net importer country and this in itself, has resulted in the gradual depreciation of the Indian Rupee against the US Dollar. Many people get tempted by foreign exchange rate movements and look at forex trading. It is easier said than done as there is plenty of speculation in the forex market about how future demand and supply for dollars will pan out and the Rupee will fluctuate against the Dollar.

Now there can be a number of other factors that can affect the supply and demand for currencies. These include:

  • Economic growth: If a country’s economy is growing, there is likely to be more demand for its currency. This is because businesses and investors will want to invest in the country, which will require them to buy the country’s currency.
  • Inflation: If a country’s inflation rate is high, the value of its currency will likely decrease. This is because inflation makes the currency less valuable, as it means that the same amount of currency can buy fewer goods and services.
  • Interest rates: If a country’s interest rates are high, the value of its currency will likely increase. This is because high interest rates make the country’s currency more attractive to investors, who will want to earn the higher interest rates.
  • Political stability: If a country is politically stable, the value of its currency will likely be more stable. This is because investors are more likely to invest in countries that are politically stable, which will require them to buy the country’s currency.

The Indian rupee has been generally depreciating against the US dollar, as we saw in the graph above, for a number of reasons. These include:

  • India’s high current account deficit: India’s current account deficit is the difference between the amount of money that India exports and the amount of money that India imports. A high current account deficit means that India is importing more goods and services than it is exporting. This puts downward pressure on the value of the rupee, as there is more demand for foreign currency than there is for Indian currency.
  • India’s high inflation rate: India’s inflation rate has been consistently high in recent years comparatively speaking.
  • The US dollar’s strength: The US dollar has been strengthening in recent years against most other currencies. This is due to a number of factors, including the US Federal Reserve’s monetary policy and the strength of the US economy. The strengthening of the US dollar has put further downward pressure on the value of the rupee.

The foreign exchange market, referred to as forex, is the global marketplace where national currencies can be exchanged against one another. These days, many participants in forex markets are equipped with algorithmic automated trading strategies, and artificial intelligence-powered analytics tools that has made the market a little too fast paced for those who might be tempted to start new.

But coming back to the question at hand about fluctuations of currencies against each other – that is exchange rate volatility. Even RBI has acknowledged in a working paper on Exchange Rate Volatility that Exchange rate volatility adversely impacts market sentiments and thereby foreign trade and economic growth. Since BRICS represent an emerging economic block, foreign capital flows get easily attracted to these economies for higher returns. However, it has been observed that capital flows are often associated with exchange rate volatility. More details are available on the central bank RBI’s site here.

And one more thing. Global politics is also inextricably connected when it comes to currency movements. Political events, from elections to trade wars, all have an effect on currency values; therefore, traders often double as geopolitical analysts in deciphering how global events might influence them and, therefore, how currencies pair.

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