Why Did the Indian Rupee Crash?

The exchange rate of the Indian rupee has fallen to more than 70 against 1 United States dollar! This is the lowest that the Indian rupee has ever been in the past five years! This sudden slide in the value of the Indian rupee has been despite the efforts of the Reserve Bank of India to contain the fall.

The speculative bets against the rupee are too numerous for the central bank to be able to contain them. Also, activity in the derivatives markets shows that the futures for rupee are selling at even lower prices. This is hinting that this may not be the end of the fall for the rupee.

In this article, we will have a close look at some of the reasons behind the fall of the Indian rupee.

• Strong Dollar: The United States dollar is the reserve currency of the world. Since it is the safest amongst all fiat currencies, it is preferred by investors. For many years in the past, the dollar has been on the decline.

  The interest rates have been at an all-time low. This is the reason why investors were not interested in investing in dollar-denominated assets. These investors could use their money to invest in other countries where they would receive higher interest rates. However, the fundamentals have changed in the past one year or so.

  The Federal Reserve has been increasing the interest rates rapidly. As a result, assets denominated in the dollar are now giving moderately good yield. This is prompting investors to allocate more money from their portfolios towards American assets.

  The end result is that these investors are selling off some of their assets in emerging markets to release money that can be used to make dollar-denominated investments.

  The general trend is that assets are being sold in emerging markets and the proceeds so generated are being remitted out of the country. This is the reason why almost all emerging markets are seeing a downfall in the value of their currency. India had been a notable exception to this trend until recently when the fall of the Turkish lira triggered the mayhem in India as well.

• Turkish Lira: Turkey has been facing some conflict with the United States. The conflicts range from purely economic to complex geopolitical issues. This is the reason why American investors and American companies are not bullish on their relations with Turkey.

  The economic situation of the Turkish nation has also rapidly deteriorated after Erdogan avoided a military coup and implemented strange economic policies across the nation. The effect on Turkey has been disastrous.

  The Turkish lira has lost more than 45% of its value against the United States dollar in the past one year. Much of this decline has been sudden and precipitous.

  The end result has been the fact that investor confidence in emerging market economies has been severely eroded. This is the reason why the Turkey contagion has been felt across many nations.

  The currency market has been facing turbulent times in general, and India is just one example of the fallout.

• Overvalued Markets: Another reason which led to the sudden fall in the value of the rupee is the fact that the India stock markets are highly overvalued. The Sensex and the Nifty are now at lifetime highs! This is strange given the fact that there are several economic challenges that the nation is facing.

  The country’s banking system is facing a huge crisis wherein bank loans worth several trillion dollars have gone bad. Also, the Reserve Bank is rapidly increasing the interest rates. All these factors should ideally lead to a fall in equity prices. However, the prices are headed in the opposite direction. This situation appears to be a bubble to many investors.

  Add to that the fact that their investments may be denominated in a rapidly depreciating currency and the reasons for investor panic become palpable. This has led to an investor sell-off. Not only debt but also equity assets denominated in the Indian rupee are now less attractive to foreign investors.

• Current Account Deficit: Some analysts had predicted that the value of the India rupee will decrease. However, they were not able to anticipate that the decline will be this sudden and this steep. The prediction was being made based on facts that the current account deficit of India is widening.

  The current account deficit is projected to grow to more than $156 billion. This is in contrast to the $108 billion deficit that India had last year. This sudden spike in the current account deficit has been because of the fact that imports have been rising at double the speed of exports as compared to the previous year.

  The rising current account deficit means that India has a higher import bill during a time when GDP growth rate has fallen. This is obviously a key factor that had led to the decline of the rupee.

To sum it up, the rupee decline has been due to a combination of weak fundamentals which have been exacerbated by turbulent external trends. The decline is likely to continue in the short term. The government will have to take strong measures to ensure that the trend does not continue in the long term.

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