Factors Influencing the Exchange Rate of Indian Rupee Against the US Dollar

The exchange rate of the Indian Rupee (INR) against the US Dollar (USD) has been experiencing significant fluctuations due to a variety of factors. One of the most recent notable events was the rupee's hit to a new low, marking a 1.7-fold decrease from 1992 to 2013.1

Outflow of US Dollars and Political Influence

The outflow of US dollars is a major factor contributing to the drop in the rupee's value. This trend was accelerated by Trump’s election, which has prompted foreign portfolio investors (FPIs) to move their investments back to the US amid fears of increased tariffs that could slow down India's economic growth.

Balance of Payments: A Key Determinant

Another critical factor influencing the exchange rate of the Indian rupee is the balance of payments. The balance of payments refers to the financial transactions between a country and the rest of the world, which include the current account, capital account, and financial accounts. The rupee acts as a medium of trade rather than a purely speculative investment vehicle, making its value largely dependent on the balance of payments.2

Current Factors Influencing the Balance of Payments

The current balance of payments is influenced by several key factors:

Foreign Institutional Investors (FII) Selloff: The FII selloff in the equities and securities markets has led to a decrease in foreign investment. This practice can lead to a decline in the demand for the rupee, thereby affecting its exchange rate.

Poor Export Performance: A poor performance in exports can contribute to a negative balance of payments, as the inflow of foreign currency from exports is crucial to support the demand for the rupee.

Lack of Credit Flow: When the flow of credit from other countries to India is low, it can lead to reduced foreign investment and remittances, further impacting the balance of payments.

Investment Flows: A lack of investment flow into India can weaken the demand for the rupee, especially if it is not offset by robust inflows of foreign capital.

Poor Remittances: Weak remittances from expatriates can also lead to a decline in the demand for the rupee, as remittances are a significant source of foreign income for India.

The Role of the US Dollar as the Leading Currency

The US dollar is the world's leading reserve currency and is often the medium of exchange for international transactions. Its strength can directly impact the value of other currencies, including the Indian Rupee. When the US dollar is strong, it becomes more attractive for traders and investors, which can lead to a decrease in demand for other currencies, including the rupee.3

Demand and Supply Dynamics

The value of the Indian Rupee (INR) is ultimately determined by the supply and demand dynamics in the international market. If the supply of rupees exceeds the demand, the value of the rupee will decrease, reflecting an unfavorable balance of payments. Conversely, if the demand for rupees exceeds the supply, the value of the rupee will increase, indicating a favorable balance of payments.4

Market Forces Determine the Exchange Rate

Exchange rates are ultimately determined by market forces, including supply and demand. When there is a high demand for dollars, and a corresponding supply of Indian Rupees, it leads to a depreciation of the INR. Conversely, a high demand for rupees against the dollar can lead to an appreciation in its value.

Conclusion and Future Outlook

The Indian Rupee's exchange rate against the US Dollar is influenced by a complex interplay of market forces, including political and economic factors. While the current political climate, such as US political decisions, plays a role, the ultimate determinants remain the supply and demand dynamics of the global market and the balance of payments between India and the rest of the world.

References

Keywords: Indian rupee, US dollar, exchange rate, balance of payments, economic policy