25 Nov 2022 Domestic Inflation & depreciation of the rupee
Significance for Prelims: Concept Purchasing Power Parity
Significance for Mains: Factors responsible for the depreciation of the rupee; Impact of depreciation and appreciation of the rupee; Method to stabilise the rupee’s exchange rate
News: In this article veteran policy maker C Rangarajan gives reasons why containment of domestic inflation is necessary to stop the slide of rupees.
Determination of value of any currency: Value of the rupee or any currency is determined through purchasing power parity.
- Importance of purchasing power parity: If as long as inflation in India is higher than the inflation in other countries, the value of the rupee will (continue to) depreciate.
- Internal value determines the external value of a currency: Difference in the inflation in the two countries governs the rate differential between one currency and another.
- Increased value of the capital account in the balance of payments: Traditionally balance of payments(BoP) was dominated by the current account i.e. export and import of goods and services, but now BoP is dominated by the capital account i.e. inflow and outflow of funds. So, the value of a currency can be strong even during a high current account deficit because there is enough external capital flowing into the country.
Factors responsible for rupee depreciation: Because of the outflow of funds and the lack of funds coming from outside.
- Decrease in the supply of foreign currency because investors are keeping deposits in their own country and this main reason for the depreciation of the rupee and currencies of other countries against the dollar.
- Funds inflow into India diminished because to control inflation in the United States, the Fed has raised the interest rate.
- Higher rate of interest in the United States: United States is more attractive for investors due to higher interest rates. So, instead of sending funds outside, they are keeping the funds inside and sometimes, withdrawing funds from India and putting them in the United States.
- Impact of undervalued currency: Exports became more attractive.
When devaluation or the depreciation of the currency is beneficial?
- In case of a tough balance of payments situation.
- Country needs to export more to reduce the current account deficit.
- But, the steady deterioration of the rupee is not appreciable.
Method to stabilise the rupee’s exchange rate:
- Reduce inflation rate: India talks of 4% as the appropriate inflation. If we keep moving towards this goal every year the value of the rupee will depreciate. India needs to see that its inflation is at least close to U.S.A inflation and that the margin is not that high.
- Control inflation by raising the rate of interest: This step is beneficial as it moderates inflation and at the same time, it does not affect the value of the rupee.
Prelims(2021):
Consider the following statements:
The effect of devaluation of a currency is that it necessarily
- improves the competitiveness of the domestic exports in the foreign markets.
- increases the foreign value of domestic currency
- improves the trade balance
Which of the above statements is/are correct?
(a) 1 only
(b) 1 and 2
(c) 3 only
(d) 2 and 3
Mains Question:
- What is the meaning of the term ‘tax expenditure’? Taking the housing sector as an example, discuss how it influences the budgetary policies of the government.
Source: The Indian Express
Article: C Rangarajan explains why it is essential to contain domestic inflation?
Article Link: https://indianexpress.com/article/explained/india-economy-rupee-inflation-reserve-bank-of-india-c-rangarajan-8286318/
Yojna IAS Daily current affairs eng med 25th November
No Comments