The Reason why Rupee is falling against Dollar

The Indian rupee is known to be the worst performing currency in the South Asia region. Continuing its worst performance it fell to its all time historic low level of 69 rupees against 1 US dollar few days back and again today.

Why is rupee falling against dollar? The fundamental reason is its demand and supply vis-à-vis US dollar’s demand and supply in the international market. We have to understand that just like any other commodity, whose price is determined by its demand and supply condition in the market, Indian currency rupee is also just another commodity, and so its price i.e., its purchasing power is also determined by its demand and supply.

The supply of rupee is solely determined by the Indian central bank RBI, which has monopoly over its supply. The demand comes from the people (both Indian and foreign).

In the market when the supply of rupee increases, when its demand and US dollar’s supply and demand are unchanged, then that results into rupee’s fall against the US dollar, and vice versa. If its demand increases, when other remaining three factors are unchanged, then it appreciates (rises) against the dollar, and vice versa. When US dollar’s supply increases, when its demand and rupee’s demand and supply are unchanged, then dollar falls against Indian rupee i.e., Indian rupee appreciates against the dollar, and vice versa. When the demand for dollar increases, when other remaining three factors are unchanged, then it appreciates against rupee i.e., rupee falls against the US dollar, and vice versa.

In present, the demand for rupee is falling against dollar because dollar’s demand is increasing in the international market. The major reason for this rising demand for dollar is the rise in the interest rates in the US as well as rising prices of oil which trades in US dollars in the international market. US central bank is raising its interest rates which is making investment in US market more attractive so big investors are pulling out their investments in the Indian market and diverting it to the US market. Also, the supply of US dollar is falling, which also results into strong dollar. With falling demand for rupee, its supply is also going higher, because RBI is printing rupees incessantly, and that’s why its purchasing power is lower both in India and in the international market.

As if the weakening rupee problem was not enough, the RBI is trying to defend rupee, instead of allowing it to trade at its market level as determined by demand and supply condition, by selling dollars in the market. This policy is dangerous because India only has some US$410 of dollar reserves, and currently RBI is burning billions of dollars to defend the rupee. These dollars are not to be used to defend rupee but to pay for India’s big import bill. The government is saying they have enough “firepower” to defend rupee, but the way rupee is falling no firepower will be enough to halt its fall. In the end the Forex reserve will deplete to levels where  it won’t be enough to import essential things in India and we will be back in the dangerous time of 1990s!

In the end, the reason for rupee’s fall is the fundamental weakness in the Indian economy due to inflationary policies of RBI and heavy government control of the economy. As long as these factors are present, rupee will never be strong.