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Reasons behind Indian Rupee Depreciation against US Dollar – The Indian Rupee Currency Conversion

One of the most visible signs of a strong economy is a stable currency. Indian Rupee has been stable for most of the 2000s which gave an impression that all is well with the fast growing economy. However, it has depreciated significantly against the US Dollar in 2011. Very few financial experts have predicted this kind of a downfall for the Indian Rupee. It has lost more than 20% of its value in 2011. Rupee is trading close to Rs 54 to a US Dollar now. Indian Rupee is now one of the worst performing currencies in the world. The rupee’s decline is based on the expectation dollar demand will remain strong due to worries over the euro zone debt crisis.

The Reserve Bank of India has, so far, responded to the depreciating rupee with minimal intervention in the market. One of the reasons is that country’s foreign exchange reserves of $300+ billion may not be enough to defend the rupee, especially when the intervention comes as a reaction to global factors. While exporting industries such as information technology, gems and jewelry, and textiles will be happy, consumers are likely to suffer. The higher cost of imported inputs across a range of products will cause an increase in their end prices, especially in the case of fuels.

The reasons for this downfall are many. India’s growing trade deficit, global slowdown and global investors’ preference for gold and US$ for safe investments, poor returns from Indian stock market (BSE Sensex lost close to 25% in 2011) are some of the reasons for this downfall. To reverse this trend, India needs to put some key strategies so that the demand for Indian Rupee increases in the forex market. These strategies will take longer term to take effects and are good for the overall economy in the coming years. Some of the probable strategies are:

• Increase exports: Depreciation of the rupee with respect to the dollar has made Indian products competitive in the global market. Hence increasing the exports is an viable option for the Indian companies

• Reduce external borrowings: According to data from the RBI, ECBs in January-September 2011 were 28.7 billion US dollars. Foreign borrowings increased as domestic interest rates became expensive due to monetary tightening by the RBI. The average rate of interest in India has been significantly higher than in international market encouraging Foreign Institutional Investors to borrow in foreign markets where interest rates are lower. India needs to reduce dependence of the external borrowings to increase demand for its currency

• Reduce imports: The cost of importing oil contributes to a major share of India’s imports. Increase in prices of oil and other commodities lead to rise in inflation. The rise in inflation leads to further outflow of capital. Further, crude oil and vegetable oils are the two major commodities in which domestic consumption demand is largely met through imports. India needs to aggressively invest biofuels to reduce dependence on fossil fuels. While this is a long term strategy, this could be a way to go for the future governments in India as far as fuel policy is concerned. Further in the case of vegetable oils, India with its vast agricultural land should promote growing oil seeds which can lower its vegetable oil import bill.