2022 was a year to forget for the Indian Rupee. It became Asia’s worst performing currency and recorded a historical downfall of 10% against the US Dollar. As the Foreign exchange reserves fell rapidly, other macro-economic indicators such as the Current Account Deficit (CAD) worsened throughout the year to reach a nine-year high. In this scenario, it is important to understand the reasons that led to the retreat of the Indian rupee to all-time lows, and examine what lies ahead for the rupee in 2023.
The reasons for the rupee’s downfall were both internal and external. While inflation did play a big role toward the decrease in its value, one of the biggest factors leading to the rupee’s downfall was the strengthening of the USD. In the post pandemic period, the United States saw inflation rates achieve new heights. The distribution of money to the public and the reopening of the US economy meant that there were more goods and services to spend money on. As a result, the economy recorded an inflation of 9.1% during July 2022. In an attempt to bring the inflation down, the Federal reserve began taking measures to incentivise investors to park funds with them, and consequently, interest rates on government bonds began to rise. Interest rates on two year bonds rose from 0.25% to 4.4%- meaning that the treasury yields increased. Treasury yields indicate how strong the USD is–the greater the interest paid on the government bonds, the stronger the USD is. Soon, there was an acute demand for the US Dollar and it began to strengthen- the Dollar Index (which measures the valuation of the USD as opposed to a basket of foreign currencies) rose to over 113. Currently, in order to prevent the value of the rupee falling further, the Reserve Bank of India (RBI) began to sell USD at the rate of Rs. 80 per USD. This way, there will be a decrease in the circulation of the Indian rupee in the market, and the market will gain a supply of USD at a time when the demand for the latter is extremely high. A reduced Rupee supply in the foreign exchange market should theoretically lead to an appreciation in its value as opposed to the USD.
Apart from the dollar’s appreciation, other internal issues plagued the rupee’s valuation as well. India’s Current Account Deficit (CAD)–the balance of the country’s imports against its exports–worsened to a nine-year low from 2.2% to 4.4% of the Gross Domestic Product or $36.4 billion USD, between April to September. A high CAD shows that the country is importing more than its exports–meaning that the domestic products are struggling to sell abroad. The Russia-Ukraine war led to a sharp increase in the prices of oil barrels, which, along with electrical equipment and semi-conductors, constitutes the major chunk of India’s imports. The depreciation of the rupee meant that the imports became costlier and the gap between the imports and the exports began to widen. The increase in the costs of imports results in a subsequent increase in the price of goods in the domestic market. Import-dependent industries such as the automobile industry are very likely to face severe production shortages.
The financial year 2022 has also seen India experience a strong money flow out of the country. Foreign investors pulled out Rs.1.22 Lakh crore from equity markets and 17,000 crores from debt markets in India during this year. This was due to multiple reasons, many of which were external- given that central banks all across the world were hiking interest rates, and the price were on the rise, investors pulled out money from Indian equity markets. Another reason for the withdrawal of money by investors was the high valuation of stocks in the Indian market. Thus, investors shifted their attention to external markets with better valuations and which had a greater risk-to-return ratio.
WHAT LIES AHEAD FOR THE RUPEE IN 2023?
The Reserve Bank of India has predicted a gradual return to stability for the Indian Rupee in the second half of 2023. The reasoning behind the prediction follows the logic that all the factors that caused the depreciation of the rupee have begun to gradually cool down.
The first reasoning, would be that the price of oil barrels have begun to drop again, from $100 per barrel to $78 barrel- resulting in the overall decrease of the value of imports by around 3 billion USD toward the end of the second half of 2022. The International Energy Agency (IEA) has further predicted a fall in the demand of oil barrels by 1.7 million barrels per day in 2023, which would result in a further drop in the value of oil barrels. This can result in the trade deficit being narrowed even further, by around 20 billion USD.
Yet another important external factor which resulted in the fall in the value of the rupee in 2022, is the rise in the value of the USD. It can be seen that while in the first half of 2022, the Dollar index is expected to be around 108-110, the Dollar index is expected to fall even below 100 toward the second half of 2022, given that the Federal Reserve is looking to cool down the interest rates.
While the possibility of the onset of a global recession and the opening up of the Chinese market pose quite a worry to the Indian rupee, recovery of domestic growth can help stabilize the rupee prices. In conclusion, while the rupee will remain to face pressure against a rising USD in the first half of 2023, it will face relief toward the second half of 2023- and face a return to stability. The GDP forecast for the Indian economy is expecting the GDP to increase by 6.8%. This, coupled with a decrease in the inflation rates and a cooldown of external factors, has led many to believe that the rupee would gain strength toward the second half of 2023.