Impact of Macroeconomic factors on India’s exchange rate in 2018

By- Puneet Dang

The exchange rate is defined as for the number of units of domestic currency, the need to buy one unit of foreign currency.  In other words, it is the rate at which one currency in one country can be exchanged for other currencies. The exchange rate is very crucial as it allows for the conversion of one national currency into another and thus it can facilitate international trade for goods and services and the transfer of funds between countries and it also allows comparison of prices of goods at the same in different countries.

So, the price difference between similar goods determines the goods traded and the place where they were sent.  However, the currency could stir volatility depending on the economic situation in the foreign exchange market in particular. This article emphasizes on the main macroeconomic variables that have a direct or indirect impact on the exchange rate movements in the countries such as India.

Fluctuations in the exchange rates may have an adverse impact on the economy. Exchange rate fluctuations or stability are the major concerns about the direction of foreign trade. Exchange rate volatility is the risk related to the unexpected movements in exchange rates.

Macroeconomic variables such as interest rates, inflation, balance of payments, tax rates, imports, exports, gross domestic product and the money supply is the effect of exchange rates. The instability of macroeconomic variables such as interest rates, inflation, balance of payments depends on the current economic situation in the country.

Factors that affected exchange rate in 2018

Inflation

In 2018 the CPI rose at a 2.2% annual rate in November. With a high unemployment rate of 4.1% the inflation for the year 2018 till November is 4.7%. Though the inflation is not so high, but it has increased over the previous year.

Current Account Deficit

The widening CAD, with imports being greater than exports, is one of the factors which is leading to depreciating Indian rupee. The CAD is expected to widen to 2.8% of the GDP in 2018, up from 1.9% in the previous year. In 2018, crude oil prices are around $70 a barrel. This was mostly weighed down by rising crude oil prices, as India imports a majority of 80% of its fuel needs. The graph shows the relation between India’s exchange rate with change in crude oil prices along with effect of global factors on USD-INR.

US-China trade war

US and China have been imposing duties on each other’s imported items lately, which is not good for the global trade. This has made analysts speculate that China may devalue the yuan to win over US. One way to cope with trade wars is currency devaluation. In order to mitigate the pressure felt on the export sector, China is devaluing Yuan. China with 3 consecutive devaluations of Yuan devalued Yuan by 3%. With devaluation, China is destabilizing global market. This step also makes Dollar appreciate in return. Since, China is an Asian country, thus this is likely to have a ripple effect on other Asian currencies, including the rupee.

Strong Dollar Prices

Another reason for 2018-rupee crisis is the strong USD to INR rates. Brexit leading to the United Kingdom European Union membership referendum, dollar is strengthening because of volatility of European Union, Investors are dumping pound and buying more dollar. In September, the rupee touched a historic low of 72.45 to the USD. In 2018 alone, INR has depreciated 12% against the USD making it one of the Asia’s worst performing currencies.

US Growth

US economy has gained strength in 2018, as it’s GDP grew 4.1% in the second quarter in 2018, which is fastest since 2014. Thus, it led to strengthening of the USD in comparison to other currencies.

India’s external debt

Currently India have an external debt of $513.4Billion dollars. This huge debt doesn’t directly play any role in depreciating Indian rupee. But this debt becomes important factor when viewed from investors perspective on Turkey. With Turkey under debt of $179 billion dollar and as % of GDP is 53.4%. For India, External debt accounted for 20% of the country’s nominal GDP in 2018. High Debt to GDP for turkey has been proven faulty for the country as country is under high debt and investors have taken their money out of country stopping country’s economy.

Turkish Crisis

US’s trade war with Turkey is another major reason for fall in the rupee. The Turkish Lira has fallen over 40% in 2018, as the US has imposed higher tariffs on Turkish steel, aluminum and other commodities. This has impacted various emerging economies, including India, as it led INR to depreciate.

Elections

The election season has created a mix of sentiments which kept on changing. Thus, the exchange rate remained volatile over the period and remained range bound. Market moved significantly when the exit poll results were out, causing rupee to strengthen against the green back. When, the markets are sure of a political stability of a nation, it leads to a stronger currency.

Implication for India

There is a thing called financial ‘contagion’ and it stems from the collected response of investors to avoid risk and move to safer investments. Turkey’s contagion is spell into Indian economy and with the factor of depreciating rupee, investors are withdrawing Indian rupee, and this is creating a vicious downward cycle. This downward trend broke due to predictions for the new government, and INR gained strength when the exit polls signaled towards a stable government formation. Thus, we expect another move for INR causing INR to strengthen when the election results are out.