Introduction

The Indian growth story is largely scripted on the strength of domestic demand, which fuels both domestic production and import consumption. Historically, India has always been under deficit since independence, and till now, the position has not improved much either. The widening current account deficit, global geopolitical tensions, the huge outflow of foreign investments have created downward pressure on INR. The value of the Indian currency has been on a free fall since then. Although government intervention and policy initiatives might have temporarily managed to stabilize this fall, however, in the long run, India has only seen depreciating currency.

History of Falling INR

Let’s understand the history of depreciating INR since independence and what were the primary reasons causing downward pressure on our currency since then…

At the time of independence, there were no external borrowings on the balance sheet of India. Still, when the Britishers left, it shook the Indian economy to the core due to a lack of capital formation and systematic planning. Britishers eroded Indian wealth, and at that time of such crisis, former Indian Prime Minister Nehru adopted a model of five-year plans (inspired from Russia). During this time, India had to rely on external borrowings and thus took heavy loans during the 1950-1960 period causing the INR exchange rate against USD ($) to fall. 

Going forward, the Indian government faced a budgetary deficit and was not able to borrow more funds from outside due to the negative savings rate. Further, the India-China war of 1962, the Indo-Pakistan war of 1965, and the huge drought in 1966 impaired production capacity, leading to severe inflation. In order to tackle inflation and open up to the world for global trade, the government purposely devalued its currency. In 1973, when OPEC decided to cut oil production, it took a heavy toll on India’s oil import bill, which again led to external borrowing and caused a fall in the value of INR. Even the assassination of then Prime Minister Indira Gandhi caused political havoc and reduced confidence of foreign investors in the Indian economy.

1991 was a transformational year in the history of the Indian economy as New Economic Policy was introduced to tackle the trade deficit, interest payment, inflation and make India a global trading destination. This again led to the fall of Indian currency as exports would become cheaper for other countries that might help tackle the above crisis. Apart from this, there were several other reasons such as the import of gold in huge quantities, the global financial crisis (2007-08), the European sovereign-debt crisis (2011) that created downward pressure, and a fall in the value of INR, which stood around $1=Rs.66 in 2016. This was the history of depreciating INR since independence but moving forward, let’s understand the current state of INR in terms of USD ($) and how it is performing today.

The Current State of INR

The global economy was finally on the road to recovery after two long years of reeling under the Covid-19 pandemic but the invasion of Russia into Ukraine has pushed forward and is anticipated to slow down this growth. The invasion led to severe economic sanctions on Russia by major western and European countries. This will potentially cause a global economic slowdown and will also create a demand & supply gap.

India imports 85% of the crude oil from abroad, and Russia contributes less than 3% to India’s total oil requirement. The heavy sanctions imposed by the United States on oil & gas imports on Russia have led to a surge in Brent crude price. 

This will lead to:

1. Increased fuel prices in terms of hiked petrol and diesel rates for Indian consumers.
2. Panic buying of edible sunflower oil imported from Russia and Ukraine.
3. Increase in raw material prices required in pharmaceutical industries. 

In short, this will lead to ‘Imported Inflation’ as huge amounts of forex will be used in paying off such hefty import bills.

Widening Current Account Deficit Impacting INR

When developed countries demonstrate strong economic growth compared to their developing economy counterparts, it creates an imbalance for the emerging markets and puts pressure on their currencies. This involves India, as, with rising oil import bills, its current account deficit widens. 

In the below-mentioned figure, we can see a QoQ comparison of Q2FY21 and Q2FY22 of India’s current account balance, where the total balance has turned negative $9.6 billion from a surplus of $15.3 billion.

This figure does not consider the Russia-Ukraine war’s latest impact, which has further widened this current account deficit due to rising crude oil prices and reduced exports. 

As per a recent ICRA report, the current account deficit is likely to widen by $14-15 billion (0.4% of GDP) for every $10/bbl rise in the average price of the Indian crude basket. If the price averages $130/bbl in FY2023, CAD will widen to 3.2% of GDP, surpassing 3% for the first time in a decade. This economic catastrophe has emerged as a byproduct of the war.

The FPI Exodus

The foreign portfolio investors have pulled out more than a lac crore from Indian equities and debt since the beginning of the calendar year 2022. This is one of the highest outflows of foreign funds from the domestic market after the panic selling in March 2020. The key factors for such huge outflows have been unsustainable domestic valuations, rate hikes by the US Federal Reserve, and the recent Russia-Ukraine saga that has unnerved the foreign investors. Going forward, uncertainty hovering around the economic growth might lead to further sell-off by FPIs, creating downward pressure on INR. This would increase rupees’ supply with no significant demand, thereby falling in value against USD ($).

Final Thoughts

India should take initiatives towards implementing reforms and policies that can stimulate exports and promote efficient capital utilization, thereby generating better returns for foreign investors. It needs to be recognized that the domestic fundamentals of the country remain stable, and the widening CAD gap and currency depreciation are a product of global factors. The recent hike in crude oil prices was due to the geopolitical tension between Russia and Ukraine which, going forward, might stabilize and help in the reduction of CAD due to reduced oil import bills. In the longer run, the rupee has the potential to outperform developed currencies as the central bank in the last two years has built significant forex reserves and made the nation “tantrum proof.”