Post-World War II, the U.S. dollar (USD) has been the most powerful currency in the world. It has dominated the financial market and has become the de-facto currency for international trade and transactions. More than 60% of global foreign reserves are in USD, making it the most commonly held reserve currency in the world. Till today, countries peg their currencies against the USD to determine their value in the global market.
The strength of India's currency, the Rupee (INR) is also weighted against the USD. The value of 1 USD to INR keeps fluctuating and it is called the exchange rate.
The exchange rate constantly changes in the global foreign exchange market and is an important determinant of a nation's economic power. The whole global trade is possible because of its existence. If the value of foreign currency increases, imports get expensive and exports get cheaper. The contrary is also true.
If it takes more Indian currency to buy 1 USD, it means that the Indian currency has depreciated and if it takes less, the currency has appreciated. Since independence, the Indian currency has been on a roller-coaster journey. Geopolitical issues, economic reforms, and international issues have affected its value over the years. Judging from the value of 72.55 rupees per dollar in the current time, the Indian rupee has been depreciating against the USD in the past 71 years.
Let's look at the history of the dollar vs rupee since 1947 to understand its journey of depreciation against the dollar.
Rupee After India's Independence
As a free country in 1947, India had no foreign debt or credit on its balance sheet. This could mean that 1USD = 1INR. However, as India was a British ruled state before its independence, the value of INR was derived from the British pound. The exchange rate was 1 pound = 13 INR. There was no standard system of comparing the world currencies before 1944, so this valuation remained constant. Since, 1 pound was equal to $2.73 at that time, the value of USD vs INR in 1947 can be calculated as 1 USD = 4.76 Rupee
As per the Bretton Woods Agreement of 1944, each country was required to peg the value of its currency to the dollar, which itself was convertible to gold at the rate of $35 per ounce. India was also part of this agreement, and hence at the time of independence, India followed the par value system of exchange rates. This was a relative exchange rate and not a fixed exchange rate.
Following is the breakdown of how the Rupee performed against the Dollar post-1947.
When India became independent in 1947, the Indian economy was in a poor state. To finance welfare and development activities, especially with the adoption of the five-year plan in 1951, the Indian government under the Prime Minister of Pandit Jawaharlal Nehru, continuously borrowed money from foreign or private sector savings starting from the 1950s onwards. Foreign borrowings increased in high magnitude in the 1960s.
Decimalization in 1957
In April 1957, the Indian rupee was decimalized and was divided into 100 naya paisa ('new' paisa). Before the decimalization, one rupee was divided into 16 annas or 64 pice. Each anna being equal to 4 pice. For a short time, both decimal and non-decimal coins were in circulation. Pre-decimal coins, half and quarter rupees were in circulation after decimalization. The rupee remained unchanged in value and nomenclature. The prefix "Naya Paisa" was removed in 1964. The decimalization of India's currency was a major step toward modernization and revolutionary change.
War and Drought in the 1960s
The Indian government was facing a budget deficit and was not in a state to borrow additional money due to a negative rate of savings. The situation was aggravated by the Indo-China war in 1962, the Indo-Pakistan war in 1965, and the major drought in 1965-1966. The defense spending at the time was 24.06% of the total government expenditure which was very high.
The value of 1 pound = 13 Rupee continued till 1966. After 1966, the INR was compared to the USD on a one-to-one basis and the rupee started witnessing devaluation.
As a consequence of economic upheaval, the then Prime Minister had to devalue the rupee to 1 USD = 7.50 INR by 1967. The devaluation made exports cheaper and imports expensive which resulted in a sharp increase in prices leading to inflation.
The par value system continued till 1971 until the collapse of the Bretton Woods System which suspended the gold standard/ convertibility of the dollar by the U.S.A.
1971-Collapse of the Bretton Woods Agreement
Hulton Archive (Photo: www.static.guim.co.uk)
India adopted a fixed rate system and was linked to the U.K. pound sterling after the breakdown of the Bretton Woods Agreement. However, by 1975, the rupee was pegged to a basket of currencies to ensure the stability of the rupee and to combat the increasing imbalances and disadvantages associated with a single currency peg.
Rupee value went down to 8.10 in 1974 as a consequence of the oil shock in 1973 because of the decision to reduce production by the Organization of Arab Petroleum Exporting Countries (OAPEC).
1991 Economic Crisis
The Soviet Union had been a crucial trade partner of India since the 1960s. However, due to the collapse of the Soviet Union in the 1980s, India's export fell by a significant proportion. Coupled with the doubling of the crude oil prices by the Persian Gulf nations in 1990, India faced a serious Balance of Payment crisis in 1991.
The interest payment made up 39% of the government's revenue and the fiscal deficit decreased to 7.8% of GDP.
The foreign reserve had dried up to a point that India hardly had the money for three week's worth of imports. The country nearly went bankrupt. India had to borrow money from the International Monetary Fund (IMF) against its gold reserves.
The exchange rate plummeted throughout the 1980s and by late 1990, the rate was 1 USD = 17.32 INR.
The economic crisis called for a devaluation of the rupee. Devaluation is the process of reducing a country's exchange rate in the international market while keeping the internal value unchanged. This was done to encourage an increase in exports and an increase in the inflow of foreign currency.
In 1991, the Reserve Bank of India (RBI) decreased the exchange rate by 11% in total as part of a well-planned move to deal with the crisis with the project named "hop, skip, and jump". With this, India ended the fixed-rate currency regime and moved towards a market-determined exchange rate system or the floating exchange rate system.
Rupee fluctuations in the 2000s
The effect of devaluation made the exchange rate 1 USD to 25.92 INR in 1992. The Indian rupee kept falling since then. By 2002, the rupee had fallen to Rs 48.99 against the US dollar.
In 2007, the rupee appreciated and reached a high of Rs 39.27 to the dollar because of the sustained foreign direct investment (FDI) inflows into the country in terms of investment to the booming stock market, increasing remittances, and growth in exporters led by the IT and BPO firms in the country.
Read more on the best remittance options for exchange rate fluctuations.
However, the global financial crisis of 2008 put an end to the trend and the rupee hit a low of Rs 51.75 by 2009. By early 2013, owing to global factors and domestic factors, the rupee fell further to Rs 56.57 per 1 USD.
The 2016 demonetization which was the discontinuation of Rs 500 and Rs 1,000 notes led to nearly 86 percent of the currency in circulation being invalid overnight. This had an adverse impact on consumption patterns, investment, and income among others. Also, the unavailability of newly printed notes meant a reduced amount of currency in circulation.
Eventually, the currency in circulation were-a new Rs 500 note and a first for the Indian currency-Rs 2,000 note- and later new notes of old denominations such as Rs 10, Rs 20, Rs 50, Rs 100, and another first- Rs 200 note were introduced.
Demonetization was a way to combat corruption and black money in the economy and to push forward digital India with an increase in the use of cashless transactions as a result of demonetization.
In 2016, the USD to INR hit a record with 1 USD = 68.77 INR, the highest rate at that time.
The global economic crisis following the coronavirus pandemic in 2020 contributed to the depreciation of the exchange rate to hit a record low which was 1 USD = 76.67 INR (March).
The current exchange rate now stands at 1 USD = 72.55 INR at the time of writing.
Union Budget 2021: NRIs now can incorporate One-Person Company (OPC) in India
According to the new budget, Non-Resident Indians (NRIs) can incorporate One Person Company (OPC) in India with no restriction on paid-up capital (the previously prescribed limit was Rs 50 lakh) and turnover (capped at Rs 2 crore earlier) and can convert into any other type of company at any time.
One basic requirement for OPC was that the member and nominee have to be a resident of India. With the residency limit reduced from 182 days to 120 days, NRIs now have an easier entry into the Indian market.
This move by the Indian government will encourage NRIs with entrepreneurial potential to come to India and set up a business in India. This will be a big boost for startups in India which means more investment opportunities for NRIs.
The potential increase in the inflow of foreign investments is better for the Indian rupee against the US dollars.
Why does the value of the Rupee fluctuate against the US Dollar?
The value of a nation's currency fluctuates primarily because it is based on supply and demand.
The money supply is the total amount of a currency in circulation. An increase in demand for a currency or insufficient supply of it appreciates its exchange rate value. In the foreign exchange market, most of the world's currencies are bought and sold based on exchange rates. The value of the exchange rates fluctuates depending on the supply and demand of the currencies in the foreign exchange market.
What controls the supply and demand of a currency?
Monetary policy is a powerful tool used by the central banks to control the supply and demand of the currency and thus influencing the exchange rate.
One of the ways the RBI controls the movement of the rupee is by changing the interest rates. For example, When RBI allowed the banks to increase interest rates on Non-Resident Indians (NRI) rupee accounts and brought them on par with the domestic term deposit rates, the inflow of funds from NRIs went up, which raised the demand for rupees and ultimately led to the appreciation of the currency. Similarly, depreciation of the rupee is caused by the decrease in interest rates.
RBI also buys and sells US dollars in the open market to control the value of the currency. Some other ways through which RBI control the availability of money in circulation, thus impacting the value of the currency is by regulating the following:
Inflation also impacts the value of a currency. When there is too much supply of money but no economic growth, prices of goods and services inflate. The central bank can counteract the situation by increasing the interest rate of borrowing money. High-interest rates discourage people to spend money. Instead, it encourages them to save money.
Inflation essentially is a measure of the degree of economic stability. A low and stable inflation rate is desirable for attracting foreign investment.
Rupee depreciated against the USD from 55.48 INR to 57.07 per 1 USD within 15 days in 2013 as a consequence of increased demand in the dollar from imports and due to foreign institutional investors pulling out capital from the debt market.
This happened despite RBI's effort to stabilize the value of the rupee by selling US dollars from its foreign exchange reserves.
A country with stable economic conditions and political situations generally has a higher exchange rate because it is in high demand in the currency market as investors are confident with their investments. Key economic indicators like the gross domestic product (GDP), unemployment rate, trade balance, inflation rates, interest rates determine the value of the currency exchange rates.
Political tensions can also negatively impact the value of the currency. As the demand decreases, the rupee will depreciate.
Various factors cause the volatile nature of the Indian currency. The value of INR is significantly affected by crude oil prices as India imports a large quantity of it. An increase in oil prices causes the value of the Indian currency to drop. As we discussed earlier, a fall in foreign investments in the Indian market, interest rates, inflation in the country also contribute to the depreciation of the INR. Devaluation of the currency makes imported goods expensive, foreign travel and fees for studying abroad become costly.
It is important to note that a strong currency is not necessarily good. The depreciation of the rupee has helped the Indian economy during an economic crisis. Lowering the exchange rate has improved the balance of trade. With a floating exchange rate system, the USD/INR are determined by market forces and several internal and external forces.
For a developing economy like India, depreciation can be a natural consequence and it is likely to continue in the future.