The rise and fall of the rupee: Factors which influence the movement
Let's look at how factors like interest rate hikes, imports and exports, employment, and foreign exchange reserves affect the rupee's movement.
The Federal Reserve recently raised its key policy rate by 75 basis points, raising the federal funds rate target range to 3.75-4 per cent. All global central banks undertook aggressive measures to combat the persistently growing inflation that was hampering the market growth.
The Reserve Bank of India (RBI) also consistently hiked interest rates but this time it wasn't simply due to inflation but also because of concerns about the rupee's value falling. In both ways, domestically through inflation and externally through depreciation against the dollar, the rupee has lost value.
We frequently read about the rupee's depreciation alongside developments in interest rate hikes, imports & exports, employment, foreign exchange reserves and other economic indicators. Let us analyse these factors and how they are related to the rupee's upward or downward movement.
Rupee and interest rates:
Every time a central bank raises its target rate, the cost of borrowing for banks also rises because they need money to fund loans or meet regulatory obligations. Naturally, banks pass these higher costs to customers and companies. The idea is that people will spend less if borrowing money costs more. Spending will decrease, which will lead to a decrease in demand and eventually, in the cost of basic goods.
Higher interest rates often attract foreign investment, seeking higher returns on bonds, which boosts a currency's value. Global investors exchange their investments denominated in their domestic currencies for holdings denominated in US dollars. The US dollar benefits from a stronger exchange rate as a result.
Rupee and import-export:
Import-export plays a crucial role in driving a country's currency's demand. For instance, the demand for the rupee will rise if India exports more to other countries than it imports from them, which will help the rupee to appreciate. The value of the rupee will fall in the reverse case. However, a country's export activity is discouraged by currency appreciation as goods become more expensive to purchase.
Rupee and employment:
Stronger jobs data raise concerns about rapid rate hikes, which cause the value of the rupee to decline against the dollar. According to the Fed, in order to ensure that inflation lowers, there will be a need to have more unemployed people. The basic idea is that if there are more unemployed people, their purchasing power is reduced, which lowers demand for goods.
Rupee and foreign exchange reserves:
Foreign exchange reserves (Forex reserves) are assets owned by the central bank or monetary authority of a country. In addition to limiting external vulnerability by preserving foreign currency liquidity to absorb shocks during times of crisis or when access to borrowing is restricted, it offers the potential to intervene in support of the country's currency.
In order to minimize excessive exchange rate volatility and protect the rupee from falling out of control, the RBI has been selling dollars, which is reducing India's foreign exchange reserves. Experts predict that the RBI will keep intervening in the foreign exchange markets because the depletion of foreign exchange reserves is not of great concern, as of now.