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The rupee-dollar fluctuation and its impact on the economy

The rupee-dollar fluctuation and its impact on the economy

By Snigdha Kalra

The DBS bank, in a research note, has said that the rupee had gained 6.8% against the dollar so far this year. It also added that “In sharp contrast to being one of the ‘fragile five’ during the 2013 taper tantrum, the rupee is one of the regional best-performers this year.”

This spells a positive for India, especially among other improving parameters such as increasing GDP growth rate, focus on infrastructural development and reforms to curb black money.

How will this affect inflation

A strong rupee is clearly beneficial for controlling inflation. This adds to the ongoing trend of falling inflation rates. Inflation fell to a record low of 1.54% in June 2017 and headline inflation is expected to fall further now that the rupee has strengthened. “A strong currency is positive for the inflation outlook and is even better when accompanied by soft global oil prices, said Radhika Rao, chief economist at DBS.

While the Reserve Bank of India (RBI) has tried to combat the continuous fall in inflation by cutting policy rates, it is still cautious in its approach. This is because it believes that the fall is only cyclical and not here to stay. As such it may still decide not to cut rates further and keep medium-term inflation at the desired 4%.

Impact on imports and exports

A stronger rupee gives consumers a reason to rejoice, as it means that imports will become cheaper. However, it may be bad news for exporters, who will now receive lesser real value for their goods. However, even within the manufacturing sector, those industries which depend highly on imported goods as raw materials can benefit from the reduced manufacturing costs.

Eventually, exports in the service sector, especially IT, stand to lose from the gaining rupee, as they are not much dependent on imports.

Expectation of a hike in Fed rates

There are expectations of a hike in key policy rates by the US Federal Reserve (Fed). If it transpires, its most visible impact will be the weakening of rupee against dollar, as it may lead to an outflow of capital from India as yields on US bonds rise. The major sufferers due to this shift in investment will be startups who survive on investment by venture capitalists.

While a weaker dollar may be good news for exporters, it will lead to problems for those in the import business. Moreover, the RBI may not cut rates further if there is a hike on the part of the Fed.

The situation on ground

On the 10th of August, Thursday, the rupee closed over a one week low against the dollar, down by 0.38% as compared to Wednesday. This was caused due to a small spur in the demand for dollars. As of the 10th, it was trading at 64.08, a fall from 64.84 on the previous trading day.

It is to be seen whether the fall was a one-time event in a streak of improvements in the value of rupee, or whether this trend is here to stay. If the rupee continues to strengthen, it will give a push to the manufacturing sector in India. If it continues to fall, well, we’ll be back where we started.

Featured Image Source: Flickr

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