Context: The rupee recently dropped sharply against the US dollar, approaching the 75 mark. In this article we discuss Rupee depreciation and its impact and solutions to protect from currency volatility risks.
Background of Rupee depreciation

• Recently, the rupee fell sharply by 105 paise. It is considered as one of the biggest single-session falls in 20 months.
• Currently, the rupee stands at 74.47 against the US dollar.

Reasons for Rupee depreciation
A combination of factors are responsible for rupee depreciation, such as

• One, concerns over Covid-19 has created uncertainty in the market. This affected the FDI(Foreign Direct Investment) and FII(Foreign Institutional Investment). So the rupee weakens further.
• Two, RBI’s Government Securities Acquisition Programme (G-SAP) that seeks to buy bonds worth Rs 1 lakh crore might be one of the reasons. It is a quantitative easing policy followed by RBI. The policy supported the government’s increased borrowing Programme through the infusion of liquidity.
• Three, the strengthening of the dollar against the euro also contributed to rupee depreciation.
• Four, RBI’s status-quo on policy rates is not helping to increase demand in the local economy. This will further impact the rupee.
• Further, the value of the rupee will also be impacted by the high bond yields in the US and the inflow of dollars into the US.

Impacts of Rupee depreciation
It has both positive and negative impacts. For instance,

• Depreciation has a positive impact for an NRI. As they are sending money back home they will get more rupees per dollar.

Similarly, Depreciation will have negative impacts on fuel costs and education cost in abroad. For example,

• One, A depreciating rupee increases the cost of crude import. A rise in cost of crude raises fuel prices and inflation. Crude import accounts for almost 20% of India’s imports.
• Two, higher education in the US might cost an annual fee of US$ 50,000. A 5% depreciation in the rupee (For example, from 72.5 to 76.125) will raise the cost for one year from Rs 36.26 lakh to Rs 38.06 lakh (Net loss Rs 1.8 lakh)

How to eliminate the Rupee depreciation and currency risk?
There are multiple options to cover the currency volatility risk. They are,

• Investing in international funds that invest in global markets through fund of funds. While the Indian investors invest in rupees, in the fund of funds the money gets invested in dollars at the current exchange rate. In case of rupee depreciation, this fund will fully protect against the currency depreciation risk.
• In this case, if a person planning for a quick investment (4-5 months) in foreign currency, there are two options to eliminate currency risk.
• One, creating a deposit account in the US and transferring the fund abroad.

Two, going for a currency hedge in the exchanges by investing in future contracts that will mature in 4-5 months. For example,

• A future contract worth $50,000, maturing in July at the rate of 74.5, will pay Rs 37.25 lakh.
• If in December, the rupee depreciates to $77, Then the contract will yield a profit of Rs 1.25 lakh.

Impact of Falling Rupee

• The cost of imports rises when the rupee falls, putting the country's households at a disadvantage. 
• This has a negative impact on India's economy, which is based on imports. However, NRIs, of whom India has a large number, can profit from depreciating currency. 

Currency Depreciation 

• Currency depreciation is a fall in the value of a currency in terms of its exchange rate versus other currencies. 
• It can occur due to factors such as economic fundamentals, interest rate differentials, political instability, or risk aversion among investors.
• Orderly currency depreciation can increase a country’s export activity as its products and services become cheaper to buy.
• Currency depreciation in one country can spread to other countries.