Why the dollar rate is increasing?
Introduction
In order to understand the reasons behind the hike of the USD price in India, we have to focus on the exchange rate trend over the past few years. In this regard, it is to be stated that the strength of the Indian Rupee (INR) had a steady declining trend since 2011. As a result of this, the price of foreign goods in India has also increased. The effect of the hike in the exchange rate had a direct impact on the fuel price over the past two or three years as fuel consumed in India is entirely purchased from foreign countries.
Figure 1: Rupee and USD exchange rate for last ten years
(Source: www.rbi.org.in)
Causes behind Depreciation of Rupee
As the oil importers of India has to pay in US Dollars a hike in Dollar price results in an increase in the price of fuels in India. The reasons behind the fall in the exchange rate may take place due to various factors such as the rise of fuel price in international market, the trade war between suppliers of crude oil and Foreign Direct Investments and Foreign Portfolio Investments in India. A brief overview of the factors that cause rupee depreciation can be discussed by considering the following heads:
1. Restriction over Crude Oil Import from Iran:
As earlier stated in Judicial Economist, the United States of America has restricted India and other oil importers from Iran to continue business relations with Iran. This has impacted the Indian Economy and the foreign policy as Iran is the third largest oil supplier after Saudi Arabia and Iraq. In this context, it is to be stated that India imports 80% of the total oil exports of Iran. Due to geographical factors, India enjoys a low shipping and carriage cost on importing oil from Iran. Apart from this, Iran offers India the longest credit period on oil purchase, which has been the most important factor that made Iran the most trusted oil supplier. Cessation of contracts with Iran results in an enhancement in the oil import cost and due to this reason; India faces a problem of the shortfall in the exchange reserve, which ultimately forces the exchange rate to increase.
2. Price Rise of Crude Oil in the International Market:
In the last three years, the crude oil price in the International Market has increased from $30 per Barrel to $80 per Barrel. As earlier stated, the enhancement in the oil price has been the result of the fall in the foreign exchange reserve in India. This chronic decrease in the exchange reserve results in a weak rupee in terms of the US Dollars. In May 2018, Brent crude oil price has reported the highest oil price at $80 per Barrel. Thus, this is also to be considered as another important factor that forced the exchange rate to fall.
3. Outflow of Foreign Portfolio Investments:
Being an important part of the global economy, India feels economic pressures of foreign countries. In this regard, it is to be stated that the decreasing trend in the Sensex and Nifty over the past two months has been the result behind losing the confidence of the foreign investors in the Indian stock market. However, NASDAQ, LSE and ASX have recorded a positive trend over the last six months. Due to this reason, foreign investors have shifted their investments from India in the last few months. In this same context, it is to be noted that the US and China tariff war has created a threat to the European and American investors to make an investment in Asian markets. This has also been another reason behind the outflow of foreign exchange in recent times.
4. Change of the US Monetary Policy
President Trump's strategy to recall domestic investment in the US has been implemented by enhancing the interest rate of the Fed. In the recent monetary policy, the Fed had increased its short-term benchmark interest rate. This rise in the short-term interest rate has been the result behind the decrease in the FPI (Foreign Portfolio Investment) and FII (Foreign Institutional Investment) in India. This outflow of the FII and FPI has resulted in a deficit in the foreign exchange reserve. Therefore, this factor is required to be considered while analyzing the reasons behind the rupee depreciation.
5. Current Account Deficit:
The current account deficit in India has a direct impact on the exchange rate as an enhancement in the current account deficit implies a shortfall of foreign currency in the hands of the central bank of the country. The export demand has risen due to the increase in the oil price in the international market. On the other hand, the new US trade policy includes higher tariffs on Indian goods in the US and therefore, the price of Indian goods in the USA has increased. Thus, the demand for Indian products in abroad shows a drastic decline in 2018. As the export of goods from India to abroad falls, the inflow of foreign exchange, mainly US Dollars is in decreasing trend. This has also depreciated the rupee.
Conclusion
From the above discussion, it is clear that the rupee depreciation is the result of external causes such as oil price in the international market and the US trade and monetary policies. Finally, it can be stated that this crisis of foreign exchange may continue due to the trade war between China and the USA and the USA-Iran conflict. However, the export from India is expected to show a positive move due to the increasing trend of exporting petroleum products.
Reference
Reserve Bank of India
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