CURRENCY DEPRECIATION
Currency depreciation refers to the decrease in the value of a country's currency in relation to other currencies in the foreign exchange market. It means that the purchasing power of the currency decreases compared to other currencies, leading to higher prices for imported goods and services.
Currency depreciation can occur due to various factors, including:
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Supply and demand: If the demand for a currency decreases relative to its supply in the foreign exchange market, its value may depreciate. Factors such as changes in trade balances, capital flows, and interest rates can influence supply and demand dynamics.
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Inflation differentials: If a country experiences higher inflation rates compared to its trading partners, its currency may depreciate as the purchasing power of the currency decreases relative to other currencies.
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Economic performance: Weak economic indicators, such as low growth rates, high unemployment, or large fiscal deficits, can lead to a loss of confidence in a country's currency, causing it to depreciate.
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Political instability: Political uncertainty or instability in a country can undermine investor confidence and lead to capital outflows, putting pressure on the currency to depreciate.
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Speculative activities: Speculators may engage in trading activities that anticipate currency depreciation, exacerbating downward pressure on the currency's value
Rupee depreciation refers specifically to the decline in the value of the Indian rupee (INR) in relation to other major currencies, such as the US dollar (USD), euro (EUR), or British pound (GBP), in the foreign exchange market. It signifies that the purchasing power of the Indian rupee decreases relative to other currencies, resulting in higher prices for imported goods and services.
Rupee depreciation can occur due to a variety of factors, including:
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Trade imbalances: Persistent trade deficits, where imports exceed exports, can put downward pressure on the rupee as more foreign currency is required to pay for imports.
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Capital outflows: If foreign investors sell Indian assets or withdraw investments from the country, it can lead to a decrease in demand for the rupee, causing its value to depreciate.
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Interest rate differentials: Higher interest rates in other countries can attract foreign investors away from Indian assets, leading to a decrease in demand for the rupee and its depreciation.
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Inflation differentials: Higher inflation rates in India compared to other countries can erode the purchasing power of the rupee, leading to depreciation.
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Global economic factors: Events such as changes in global oil prices, geopolitical tensions, or shifts in investor sentiment towards emerging markets can also impact the value of the rupee
| Subject | Appreciation of Currency | Depreciation of Currency |
|---|---|---|
| Definition | Increase in the value of a currency relative to other currencies. | Decrease in the value of a currency relative to other currencies. |
| Effect on Imports | Imports become cheaper. | Imports become more expensive. |
| Effect on Exports | Exports become more expensive for foreign buyers. | Exports become cheaper for foreign buyers. |
| Trade Balance | May lead to a trade deficit as exports become less competitive. | May lead to a trade surplus as exports become more competitive. |
| Inflation | May contribute to deflationary pressures as imported goods become cheaper. | May contribute to inflationary pressures as imported goods become more expensive. |
| Interest Rates | May lead to lower interest rates as a stronger currency reduces inflationary pressures. | May lead to higher interest rates as a weaker currency increases inflationary pressures. |
| Foreign Investment | May discourage foreign investment as returns become less attractive. | May encourage foreign investment as returns become more attractive. |
| Domestic Production | May discourage domestic production as exports become less competitive. | May encourage domestic production as imports become more expensive. |
| External Debt Burden | May increase the cost of servicing external debt denominated in foreign currencies. | May decrease the cost of servicing external debt denominated in foreign currencies. |
| Purchasing Power | Increases the purchasing power of domestic consumers and businesses. | Decreases the purchasing power of domestic consumers and businesses. |
| Government Policy Response | Central banks may intervene to prevent excessive appreciation through measures such as foreign exchange interventions. | Central banks may intervene to stabilize the currency or support exports through measures such as interest rate adjustments or currency interventions. |
| Subject | Depreciation | Devaluation |
|---|---|---|
| Definition | Decrease in the value of a currency in the foreign exchange market due to market forces. | Deliberate and official decrease in the value of a country's currency by the government or central bank. |
| Cause | Market forces such as changes in supply and demand, economic conditions, or investor sentiment. | Implemented by the government or central bank to address economic challenges or achieve specific objectives. |
| Effect | Affects the exchange rate of a currency relative to other currencies, making imports more expensive and exports more competitive. | Affects the exchange rate of a currency in the foreign exchange market, making imports more expensive and exports more competitive. |
| Economic Implications | Can influence trade balances, inflation, interest rates, and economic growth. | Can influence trade balances, inflation, interest rates, and economic growth. |
| Policy Response | Central banks may intervene to stabilize the currency or address excessive depreciation through measures such as foreign exchange interventions or monetary policy adjustments. | Deliberate policy action undertaken by the government or central bank, which may involve announcing changes in the official exchange rate, adjusting monetary policy measures, or implementing structural reforms. |
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For Prelims: Current events of national and international importance.
For Mains: GS-III: Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment
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Previous Year Questions
1.Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of the Indian rupee? (UPSC CSE 2019) (a) Curbing imports of non-essential goods and promoting exports (b) Encouraging Indian borrowers to issue rupee-denominated Masala Bonds (c) Easing conditions relating to external commercial borrowing (d) Following an expansionary monetary policy Answer (d) The option that is not the most likely measure the Government/RBI takes to stop the slide of the Indian rupee is: (d) Following an expansionary monetary policy An expansionary monetary policy involves increasing the money supply and lowering interest rates to stimulate economic growth. While this policy may indirectly influence the value of the rupee, it is not typically used as a direct measure to stop the slide of the currency. In fact, an expansionary monetary policy may potentially contribute to further depreciation of the rupee if it leads to capital outflows or inflationary pressures. The other options, (a), (b), and (c), are more directly related to measures that the Government/RBI may take to address currency depreciation, such as curbing imports, promoting exports, encouraging rupee-denominated bonds, and easing conditions for external commercial borrowing |
