The Cause Of A Falling Indian Rupee

The logic is quite simple but you need to understand the concept of Current Account Deficit (CAD) and Oil Imports.

Account Deficit occurs when more money leaves the country than the amount that comes into the country. Money comes to the Indian economy through Foreign Direct Investment (FDI) when a foreign company invests in a business in India. For example, Vodafone, a UK based company investing in telecommunication sector is an example of FDI. There is also the inflow of cash to India when we export goods and services.

Usually, the developed countries have more current account deficit (in the negative). India, being an emerging market has time and again clocked Account Surplus. Here is the trend of CAD in India since independence (see the figure below). As of third quarter of 2018, the CAD (Current Account Deficit) of the USA is more than India. But still, we feel the heat, why?

Reason #1: Demonetization

The harshly criticized Modinomics actually worked well for India till the first three quarters of 2016 with India recording Current Account Surplus after over a decade (the last time being in 2004). The Indian Prime Minister would be remembered for his policies like ‘Make In India’ to make trade easier for foreign companies in India (until demonetization).

After demonetization in late 2016, the Indian economy ruined and it is continuing to ruin further. Demonetization is NOT a great economic decision to have been taken by the Indian Prime Minister.

Results of Demonetization:

  • Loss Of Foreign Direct Investment (FDI): Investors lost faith in the mercurial Indian market. Here is the graph (see figure below) which shows that India records the lowest FDI in 5 years in the second quarter of 2018. India’s FDI has continued to decline since demonetization (Check the sharp depressions in between 2016 and 2018. ). Please don’t get blindfolded by the sharp peak in just one quarter of 2017–18. It’s peanuts. Many foreign investors have already sold their equity and debt funds they held in India.
  • Impact on Tourism and Hospitality Industry: Growth of India’s tourism and hospitality industry stagnated for over a year. It has now started to recover though. A quick fact: Tourism and Hospitality industry contributes to 3.8% of India’s GDP as opposed to 2% contribution of the Mining Industry.

Reason #2: Rise Of International Oil Prices and US Politics (read Trump Effect)

Monopoly and rough tactics of the OPEC countries are responsible for the rise in oil prices. Organization of Petroleum Exporting Countries (OPEC) is an international body of 14 countries who have cut down their oil production since November 2016 leading to a rise in oil prices. These 14 countries hold 80% of the world’s oil reserve and account for over 60% of oil exports, thus playing a monopoly.

Now, India has started to import oil from the USA, which is a non-OPEC country. India produces a mere 18% of its own requirement of crude oil.

The US has imposed sanctions on the import of Iranian oil. India imports almost 10% of its crude oil from Iran. Because of the restrictions laid down by the USA, India cut down the oil imports from Iran which affected the prices. After all, less supply and more demand is likely to hike prices. Although the US oil costs at least 10% lower than the Iranian oil, the quality is not so great for every oil refinery.

The oil prices are likely to soar from November 4 onwards because of the US sanctions on Iran. Thus, several countries will cut down imports from Iran and Iranian production of oil is likely to be affected. So, again low production of oil and high demand leads to a price hike.

So, India imported crude oil at higher prices in 2017 and 2018 than the usual price, thus leading to Current Account Deficit (more money flows out of the country).

Reason #3: Stronger US Economic Market and High Yielding Government Bonds

The US economy has been rising fast. Although it’s a naive way of writing, a more specific approach way of telling you is that the Federal Reserve of US has increased the rate of interest on lendings. Basically, for getting a credit, say your pending credit card bill, you need to pay more interest. Since you have to pay more at the end of the month, the inflation is high.

Higher inflation leads to higher earnings for the government. The yield on government bonds in the US has reached an all-time high in a decade (see the graph below). Thus, the US economy has become stronger. Now, the Federal Reserve has more money in their account ( A very layman sentence).

You can read about this later here.

What happens when the Fed Increases The Rate Again?

There are more reasons out there. But these 3 reasons are enough for the general audience.

2 thoughts on “The Cause Of A Falling Indian Rupee

  • 18th January 2019 at 6:27 pm

    Wow, this was great. Keep writing this kind of stories, you will get a lot of people to this text if you continue working on this.

    • 25th January 2019 at 6:34 pm

      Thank you Crista!


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