theIASHub | 18 Jan, 2025
Devaluation of Rupee: The Indian rupee recently registered a sharp devaluation with respect to the dollar after remaining stable for over two years or so.
o Higher Import Costs escalate prices for imported goods, especially energy and raw materials.
o Adjustments in monetary or exchange rate policies by the Reserve Bank of India.
o Nominal Exchange Rate represents the cost of acquiring one unit of foreign currency using domestic currency.
o Determinants of Change: Influenced by demand and supply in the foreign exchange market.
o Central Bank Policies: Shaped by the exchange rate strategy adopted by the RBI.
o Increased Import Costs: A weaker rupee elevates the cost of imports, notably crude oil, leading to higher domestic fuel prices and potential inflationary pressures.
o Foreign Exchange Reserves Decline: To stabilize the rupee, the Reserve Bank of India (RBI) has intervened in the forex market, resulting in a reduction of foreign exchange reserves to a 10-month low of $625.87 billion as of January 10, 2025.
o Impact on Importers' Hedging Strategies: Importers utilizing the 'seagull' option strategy for hedging have faced increased costs due to the rupee's sharp depreciation, as this strategy doesn't lock in a fixed exchange rate.
o Capital Outflows: The rupee's decline has coincided with significant foreign portfolio outflows, with investors withdrawing approximately $6 billion from Indian stocks and bonds in January 2025, exacerbating the currency's depreciation.
o Monetary Policy Challenges: The rupee's depreciation complicates the RBI's monetary policy decisions, particularly concerning interest rate adjustments, due to heightened inflation concerns stemming from increased import costs.
o Historical Context: India has previously faced currency devaluations, notably during the 1991 economic crisis, which led to significant economic reforms and liberalization measures.
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