Why Rupee is depreciating?

The rupee has plunged by around 2% in just a week. Ironically, during the same period, markets saw inflows of up to $2.4 billion. This brings us to the riddle - What is driving the rupee lower to nearly its 8 1/2-month low???

1.       Dollar On A Horse Ride

The main reason causing the rupee to fall is the immense strength of the Dollar Index, which has touched its three-year high level of 84.30. The record setting performance of US equities and the improvement in the labour market has made Americans more optimistic about the outlook for the US economy, thereby spurring greater hopes of narrowing the Quantitative easing program. The Federal Reserve is in a very different position versus the ECB, BoJ and the RBA (Australia). The Federal Reserve is talking about tapering asset purchases at a time when European officials are considering more aggressive monetary easing measures such as negative deposit rates. The thought of dollar being a 'safe haven' is again into the limelight.

2.       Recession in the Euro Zone Is Back On the Table

The rupee is also feeling the pinch of the recession in the Euro zone. The euro, which was seen holding the key level of 1.30 (against the dollar), has dropped lower to 1.28 levels on the back of deterioration in the local economic data. For the past month, investors have been selling Euros and buying dollars on the premise that the Euro zone is in a recession; and the ECB is considering more stimulus at a time when the Fed is considering less. If the data shows a deeper contraction in Europe, the EUR/USD could extend its losses.

3.       High Imports

The country with high exports will be happier with a depreciating currency; the same does not apply for India. India, on the other hand, does not enjoy this luxury, mainly because of increasing demand for oil, which constitutes a major portion of its import basket. The fall of the oil price to US$90/barrel has helped India to fight the depreciating rupee up to some extent but at the same time the Euro zone, one of India's major trading partners is under a severe economic crisis. This has significantly impacted Indian exports because of reduced demand. Thus India continues to record a current account deficit of around 4.3%, depleting its Forex reserves in the bargain and thus depreciating the rupee.

4.      Balance Of Payments

The Government was relaxed with respect to the CAD issue as there was a sharp fall in the commodity prices (of gold and crude oil). A large part of the import bill is driven by other resources as well. The facts show that fertilizer imports surged by 30% in the last two years and coal imports have doubled. Therefore, the problem of CAD continues to persist. With the reduction in exports and an increase in imports, on one side the current account deficit has increased while on the other, the fiscal deficit is also expected to be above the comfort levels due to increased subsidy. Therefore the imbalance between payments and receipts have increased resulting in greater deterioration of Balance of Payments.