Depreciation leads to imports becoming costlier which became a worry for India as it meets most of its oil demand via imports. Apart from oil, prices of other imported commodities like metals, gold etc rises pushing overall inflation higher. Exchange rate risk also drives away foreign investors which in turn depreciates the local currency. Thus, Indian Rupee got trapped in this vicious cycle.
There were various external and internal factors that lead to this situation. Large imports and weak exports caused imbalance of payments leading to the depreciation of local currency. The ever rising inelastic demand of oil where payment is made in dollars and India being the largest buyer of gold globally pressurized the demand side of dollar. Whereas the weak exports due to contraction of industrial production in various important sectors due to low demand from the world at the time of Eurozone Crisis and negative sentiments of the investor due to poor governance lead to withdrawal of money by foreign institutional investors, became the reasons for the less capital inflows on the supply side. But the major setback that was the most important cause of rupee depreciation was the announcement effect of Ben Bernanke statement on withdrawal of Quantitative Easing Policy in June 2013. Quantitative Easing is a credit easing process where Federal Reserve of USA bought private assets to stabilize financial markets. Thus the revival of US Economy where interest rates started to rise lead to the withdrawal of money from the emerging economies like India and creating an imbalance.
The RBI and the government came with various reforms to stem the depreciation of rupee whether hiking the duties on import or regulating the quantity of import. The limits on foreign ownership and interest rate limits for NRI’s were liberalized. Inflation linked bonds, currency swapping and curbing speculation were few measures taken by the RBI and the government. Now, in recent times rupee has gained back due to large inflows on account of positive sentiments and expectations from the new government in the Centre.Environment is becoming conducive for investors with Indian stock market creating a new high. Recent reforms of FDI in insurance sector will give a boost and the measures of fiscal consolidation have lead to stabilization of rupee. Indian Economy is back to revival mode but there is still a need of Administrative reforms and congenial environment so that India gets on track of growth in the coming years.
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