Rupee's travails: What has led to the fall, and what can Reserve Bank do?

The foremost reason for the currency's fall is the money being pulled out from the Indian economy by the FPIs and FIIs. In the last six months, FPIs have pulled out Rs 2.32 trillion

The rupee has been under immense sell-off pressure since the beginning of 2022. The situation has worsened since the Russia-Ukraine war broke out on February 20, 2022. On February 21, 2022, the rupee stood at 74.49 against the dollar. On July 8, it was trading at 79.24, 6 per cent below the rate on February 20. During these four and half months, the Indian currency has hit its all-time low several times. The latest one was on July 5, when it hit 79.38 per US dollar.

Why is the rupee falling?

The foremost reason for the currency's downfall is the money being pulled out from the Indian economy by foreign portfolio investors (FPIs). FPIs have pulled out Rs 2.32 trillion from the economy in the last six months. Much of it was due to interest rate hikes by the central banks to contain the burgeoning inflation.

A hike in interest rates also leads to an increase in the returns on deposits. So, foreign investors usually pull out the money from less-safer investment options and park it in banks and other financial institutions.

Another reason for the rupee's fall is the rising dollar index. If the index rises, the value of other currencies falls. On February 21, the index stood at 96.12 and was trading at 107.08 on July 8, an increase of 11 per cent. 

The fall in the value of the rupee can also be attributed to a rise in the prices of commodities due to the Russia-Ukraine war. Russia and Ukraine are major suppliers of items like oil, wheat, and fertilisers. With much of the supply being halted due to the war, the prices have gone up, and India’s import bill has shot up.

In simple terms, a high import bill leads to a depreciation in the value of the rupee as the payments are made in US$, reducing the availability of dollars in the domestic economy.

How is it a problem for the RBI?

The Reserve Bank of India (RBI) sold dollars in the market to arrest the fall of the rupee. In March 2022, the central bank sold $20 billion in the spot market, its biggest sale ever. This has led to a depletion in the forex reserves. In 2022 alone, forex reserves have fallen by $50 billion to $593.3 billion.

Also, out of India's total external debt of $621 billion, over $200 billion is due to be paid in the next few months. With the forex reserves falling, things may get challenging to steer through.

What can the RBI do to arrest the rupee's fall?

The RBI has been taking several steps to stop the depreciation of the rupee. It has removed the cash reserve ratio (CRR) and statutory liquidity ratio (SLR) limitations on foreign cash non-resident bank or FCNR(B) accounts. It has also allowed a higher interest rate on the NRI deposits.

The central bank may buy back the bonds from the market to increase the rupee supply. This might help it bring down the value of the dollar. Also, one of the other ways is to suck the liquidity out of the market. This can be done by hiking the interest rates. If the bank interest rates are higher, people tend to deposit more in their banks, reducing the liquidity. On these lines, the RBI has hiked the repo rate by 90 basis points in the last two months.

With the Ukraine war dragging and inflation likely to remain a global worry, the rupee’s troubles and RBI’s challenges may not disappear soon.