Why has the INR been falling against the USD?

The rupee has fallen roughly 20% against the dollar in the last five years. For Indians, importing goods is getting more and more expensive, and it is important to wonder, if we are getting the short end of the stick. So what are the reasons for the weakness of our currency to the dollar?

Well, India has had a considerable trade deficit for many years, that is, we import much more than we export. And that means, we have to essentially sell rupees and buy dollars for all the extra amount of exports over imports, since most of our (and the world’s) trade is carried out in terms of dollars. By the way, you can read about the path of the US Dollar to “Global Reserve Currency” status here.

Since most countries need US dollars to trade in the world market for goods and services both, the US dollar stays relatively strong. And by the same logic, since there is not too much demand for the Indian rupee, our currency hasn’t risen against the dollar, according to the simple laws of supply and demand.

Another reason is the difference in interest rates set by the central banks in both countries. The interest rate in the USA right now is 5.5%, while the same in India is 6.5% (This difference has decreased in the last year due to the US Fed raising rates aggressively). Using these numbers, couldn’t we just borrow $100 in the US and invest that in India for a risk-free 1% return?

As you know, there are no free lunches in our world. How this $100 example would work right now is, you borrow $100 in the US at 5.5%, and would be expected to return $100 + 5.5% of $100 = $105.5 at year-end. Say, you invest that money in India, which makes that investment worth Rs. 8267 roughly right now. At 6.5%, that money would become 8267 + 6.5% of 8267 = Rs. 8804.36 in one year.

If the rupee stayed at 82.67 per dollar after one year, you would have kept the Rs. 537.55 in your pocket. But, no free lunches, so what would really happen is that the rupee would depreciate to 8804.36/105.5 = Rs 83.45 per dollar, and you Rs. 8804.36 would give you $105.5 only after the year.

Also, due to money-printing that followed the pandemic in 2020, inflation rose worldwide, and central banks have raised rates to tackle that problem. Since interest rates in the USA are much higher than 2 years prior, big investors would much rather park their money in the USA for the high “risk-free” return than in developing economies like India where the risk is higher than in developed economies (theoretically at least).

So now you know some of the reasons for the weakening of our currency against the dollar. And well, that’s it for this article. You can read all my articles here. And do let me know if you want a specific topic covered! Subscribe for free to receive more posts like this every day!