What are the reasons for recent rupee downfall?

Why Rupee is going down?

I will try my best to explain in layman's terms, though many aspects may not be that perfect. Yet I am just trying here.  

Its all over the news. Indian Rupee hit the all-time low mark of 62 rupees against the US dollar today(16th August 2013) .  

What exactly does the term Rupee Depreciation mean?

In simple terms, Rupee depreciation means that the rupee has become less valuable with respect to US dollar and other countries can buy more from Indian markets by spending the same amount of dollars, which in turn means that our exports are more lucrative to foreign countries.(Since all the business transactions are carried out in US dollars).

Major Causes of Rupee Depreciation

1) Demand Supply Rule:    

Why does rupee fluctuate?

The value of a currency, like any traded goods or services, depends on demand and supply. If there is more demand of dollars in the currency market and is not adequately matched by the supply, other things remaining equal, the rupee price of dollar will go up or the rupee will depreciate. Conversely, if the supply of dollar is higher than the demand, the rupee will appreciate. We are referring to dollar as it is the most preferred hard currency for cross-border transactions.  

What affects demand and supply?

The supply of dollars depends on two factors—exports and investments. When goods or services are exported, the exporter gets the payment in dollars which is converted into rupees in India, boosting the supply of dollars. On the other hand, if individuals or companies buy goods and services from abroad, they need dollars to settle the bills, leading to an increased demand of dollars.

If a country exports more than it imports, the currency will tend to appreciate and vice-versa.  

Now, every country has an external account to keep a track of the cross-border transactions being carried out. This external account has two components:  

Current Account: Cross-border transactions in the goods and services market is recorded in the current account .

Capital Account: This records cross-border flow of investment and debt.  

Why is rupee depreciating?

India runs a current account deficit, which gets compensated by the inflow on the capital account (foreigners investing in India, including direct and portfolio investments).

In recent times, our current account deficit has widened and capital flows are not being able to bridge the gap. In the quarter ending June, the deficit expanded to 6.7% of the gross domestic product compared with 4.3% in the same quarter last year. As a result, the demand for dollars is high, while the supply remains low. Hence, the rupee is falling.

2) Dollar gaining strength against the other currencies:

The Reserve Banks of Eurozone and Japan are printing excessive money due to which their currency is being devalued. On the other hand, US Fed has shown signs to end their stimulus (Stimulus is a plan devised by the central banks to counter a weak economy by jump starting it. During stimulus a government takes unprecedented actions such as lowering interest rates, increasing government spending and quantitative easing so as to put some life in the struggling economy. The side effect includes weakening of currency) .

Hence, making the US dollar stronger against the other currencies including the Indian rupee, at least in the short term.    

3) Oil prices:

It is another factor that puts stress on the Indian Rupee. India is in the unhappy situation where it has to import a bulk of its oil requirements to satisfy local demand, which is rising year-on-year. The domestic demand for oil increases which causes the price of oil to increase in the international market. The demand for dollar also increases to pay our suppliers from whom we import oil. The effect is cumulative like an Avalanche breakdown. This increase in demand for dollar weakens the rupee further.  

As suggested by Tushar A. Katira,the main reason why government is directly responsible on this front is because of it's policy paralysis. The Indian government's present policies on Oil & Gas subsidy is why the prices are going high.Much remains to be done by the government on this aspect.  

55% of India's oil imports are used for transportation of goods and people. And 50% of that or 27% of the total is used for transporting the 1.8% Indians who own cars from A to B in cars that weigh at least 15 times the weight of the owners (the Maruti Alto weighs 1156kg and an average Indian less than 70kg). This private transport is subsidized explicitly (if the car is diesel powered) while Indian Railways and rail travelers are forced to pay un subsidized market prices for diesel. Who Benefits From India's Diesel Subsidy? By S.G.Vombatkere

So 1.8% of the car owning public is majorly responsible for the oil demand and oil imports and the Rupee depreciation thanks to the policies of our allegedly "pro-poor" government.    

4) Volatile domestic equity market:

Our equity market has been volatile for some time now. Equity is nothing but the investments in Indian companies made by Foreign Institutional Investors(FIIs). Some examples of Private equities investing in India are Blackstone, IFC, Berkshire Hathaway etc.  

So, the FII’s are in a dilemma whether to invest in India or not(because of the lack of overall confidence in the Indian economy as explained later in my answer). Even though they have brought in record inflows of dollar to the country this year, chances are they may be thinking of taking their money out of the equity market, which might again results in less inflow of dollars in India. Therefore, decrease in supply and increase in demand of dollars results in the weakening of the rupee against the dollar.  

Repercussions of falling Rupee

Significant depreciation affects the overall confidence in the economy and policy making becomes difficult. Importers have to shell out more rupees for the same amount of goods in dollars leading to inflation. For example, suppose an Indian buyer pays Rs 50 for an article priced at $1. If the currency depreciates to Rs 60, the buyer will have to pay Rs 10 extra for the same article, still priced at $1.

It hurts foreign investors as they get fewer dollars for the same amount of rupees realized. It also increases the liability of companies having dollar debt as they need to earn more rupees to repay the same debt. It, however, benefits exporters as goods become cheaper in dollar terms.