In early 2018, Himakshi started planning the US trip. She had been saving for the last four years and thought she had enough for her goal, irrespective of hotel charges, travel tickets etc. Inflation led to an increase of 6-7%. However, Himakshi was in for a rude awakening when she learned that her expenses could increase by more than 20% due to the depreciation of the rupee against the US dollar.
Over the past four years, the Indian currency has weakened to around Rs 77 per dollar as against Rs 63.5 per dollar in January 2018. This means Himakshi had to pay around Rs 63.5 for every dollar in 2018, but now she will have. To open close to Rs.77 for a dollar. Simply put, he has to spend 21% more in rupee terms to buy the same dollar. This is called rupee depreciation, which basically means fall in purchasing power in rupee terms.
Now a fall in the rupee does not just affect your foreign travel. It can also hit your pocket with higher fuel prices, higher interest on your loans, etc. This blog will explain the impact of sharp depreciation of rupee on your finances. Lastly, we will also explain the ways to deal with the falling rupee. But to begin with, let us first understand the factors that have pulled the Indian currency to its all-time low.
Reasons for depreciation in Indian Rupee
The value of Indian currency or any other currency depends on its demand. If the demand for a currency increases, so does its value (this is called appreciation). And if the demand for a currency falls, its value also goes down (depreciation).
When more and more foreign investors invest in India, the demand for Indian currency increases. This is because when foreign investors or companies invest in India or buy a product from India, they first convert their currency to Rupee as they can invest in Indian markets only in Rupee. As a result, demand for the Indian currency increases, and its value strengthens against the US dollar and other currencies.
On the other hand, when Indian individuals and companies import something (like crude oil, gold, etc.), they have to pay in dollars (the real global currency). So sell rupee to buy Indian dollar because US dollar is the currency of payment for international trade. As a result, the demand for the dollar increases, and the rupee weakens against the US currency.
Since India has been a net importer (we import more than we export), the rupee has depreciated gradually over time. The following chart shows how the rupee has weakened against the US dollar over the past 30 years.
As the upward trend of the graph shows, you had to spend 26 rupees for 1 US dollar in January 1992. But now you have to pay around 77 rupees for one dollar. This means that the rupee has depreciated by an average of 3.7 per cent every year against the US dollar.
Given that India has been a net importer, the gradual depreciation of the Indian currency is never a major concern. However, if the rate of depreciation of the rupee is sudden, then it is a worrying situation. In that context, it is a bit worrying that the rupee has depreciated by over 3.2% within a month. And there are two primary reasons for this fall in the rupee:
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Foreign investors exiting Indian markets
Foreign investors are pulling out of their investments in India amid the US Fed’s announcement of raising interest rates in the US and the Russo-Ukraine war. When foreign investors redeem their investments in India, they get their money in rupees. But they have to convert their holdings (in rupees) into dollars. So they will buy dollars for rupees. As a result, the demand for the dollar strengthens, and the demand for the rupee declines. As a result, the value of the Indian currency depreciates against the US dollar.
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Dollar buying gains momentum due to rise in oil prices
India is a net importer of crude oil. Since global oil prices have risen by more than 60% since the start of 2022, Indian companies will have to spend more dollars. This means increased demand for the dollar and consequently a weaker rupee.
Now that we understand why the rupee has hit its all-time low, let’s take a look at how it can affect your finances.
Rupee depreciation: Impact on your finances
A sharp depreciation in the rupee can affect your finances in 3 important ways. Let us understand the reasons in detail.
When Indian companies import something, they need to buy dollars to meet their payments, as we mentioned above. If the rupee weakens against the dollar, it will be costly to import crude oil. Similarly, imported products such as electrical machinery, mechanical equipment, precious metals (such as gold), etc., which India imports, will also become more expensive.
As a result, the by-products of these imported materials are also likely to be more expensive. Companies may not be able to absorb this increase in cost and pass it on to consumers. As a result, overall inflation in India may rise at a faster rate than expected.
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Possible hike in interest rates – Higher FD rates and loans
In a healthy economy, a moderate level of inflation is good because it does not bother consumers and encourages business activity. However, a sudden increase in inflation is never ideal for the economy.
In India, the government has given the responsibility of keeping inflation under control to the RBI. If the RBI expects that inflation will go beyond its tolerance limit for some reason, it raises the repo rate to deal with inflation. If you want to understand this in detail, we have a blog which explains why RBI raises interest rates to tackle inflation.
When RBI raises interest rates in the economy, the cost of borrowing for banks also increases. As a result, banks pass this on to their account holders by increasing the interest rate on loan and deposit rates.
There has been no interest rate hike recently as RBI is keeping inflation under check to support growth. But globally central banks are planning to increase the interest rate in their country. If inflation in India remains stable, we may soon see some rate hikes as well.
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Your investment portfolio may see a decline
As foreign investors are exiting Indian equities (read here to know why), this is causing the rupee to depreciate. The stock markets fell sharply due to the exit of foreign investors. As a result, your investments in stock and equity mutual funds may also see a decline.
Not just equities, your returns in debt funds too can be low. This is because if the depreciation of the rupee causes a sharp increase in inflation, the RBI will increase the interest rates. And debt funds tend to perform poorly during rising interest rate scenarios.
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Traveling and studying abroad will be more expensive
One of the most obvious effects of the rupee depreciation is that foreign travel and foreign education expenses are likely to rise. As mentioned earlier, you will have to pay more rupees for every dollar the rupee depreciates. So your cost will inevitably increase.
Conclusion: How can you deal with rupee depreciation?
While sharp depreciation of rupee is a negative development for your finances, there are some ways to take advantage of it. For example, you can convert rupee depreciation into your profit by investing in an international fund. When you invest in International Funds, you get exposure to Forex by investing in Rupees. Any increase in the value of the foreign currency or any depreciation in the rupee will increase your returns.
Another strategy to deal with rupee depreciation can be to tilt your portfolio towards companies that have a substantial portion of foreign exchange earnings. For example, companies related to IT, FMCG and Pharma sectors. Such companies are more likely to report higher revenue and profit growth as their products become cheaper overseas, and margins remain intact. Thus, these companies have a better chance of facing the depreciation of the rupee.
In short, the solution to dealing with situations like sharp depreciation of the rupee lies in building a diversified portfolio. And rebalance the portfolio on time to protect your finances.
