Depreciating Rupee Causes, Impacts and Action

By:
Vipul Bali, PGP2011-13
IIM Rohtak
9991600363, vipul.bali@iimrohtak.ac.in

Causes:Current Account Deficit: To finance this deficit India has to depend on Foreign
Investments or its Exchange Reserves, thereby increasing the demand for dollar, resulting in
depreciating Rupee.

Persistent inflation: India has experienced high inflation above 8% for almost two years.
It has led to overall worsening of economic prospects and capital outflows and eventual
depreciation of the currency.

Lack of reforms: There have been very few meaningful reforms in the last few years in
Indian economy. Certain well planned policies like Direct Tax Code (DTC) and Goods and
Service Tax (GST) and are in the pipe line for years.

Continued Global uncertainty: Owing to uncertainty prevailing in Europe and slump

in international market, investors prefer to stay away from risky investment (flight to
security).

Impacts:Depreciation leads to imports becoming costlier which is a worry as India meets most of its
oil and other imported commodities like metals, gold demand via imports. Even if prices of
global oil and commodities decline, the Indian consumers might not benefit as depreciation
will negate the impact. The depreciating rupee will add further pressure on the overall
domestic inflation and since India is structurally an import intensive country, as reflected in

the high and persistent current account deficits, the domestic costs will rise on account of
rupee depreciation.

Actions:By RBI:Using Forex Reserves:- RBI can sell forex reserves and buy Indian Rupees leading to
demand for rupee.

Raising Interest Rates:- The rationale is to prevent sudden capital outflows and
ultimately lead to higher capital inflows. But Indias interest rates are already higher than
most countries.

Make Investments Attractive:- RBI can increase the FII limit on investment in
government and corporate debt instruments. It can invite long term FDI debt funds in
infrastructure sector. The ceiling for External Commercial Borrowings can be enhanced.

By Government:Government should take some measures to bring FDI and create healthy environment for
economic growth. Key policy reforms that should be initiated includes rolling of Goods and
Services Tax (GST), Direct Tax Code (DTC), FDI in aviation and retail, Companies Bill and
diesel decontrol.