Understanding Indian Rupee ₹

For a basic and simple understanding base currency can be assumed as a commodity which is to be purchased by paying price currency. 

Types of exchange rates

 - Fixed Exchange rate - Rate is pegged by selling or buying foreign exchange by the central bank. Helps in standardization of exports and stabilization of inflation rate. Biggest hinderance is that to maintain fixed rate central bank needs to have huge reserves. Ex. SAR (Saudi Rial)

 - Floating Exchange rate - Rate is set to be decided by the market forces and no intervention by central bank to alter the rate. Ex. JPY  

 - Managed floating rate - Determined by market forces but altercation to keep inflation and trade deficit stable actions are taken by central bank occasionally. Helps to keep competitiveness in trade. Ex. INR

No exchange rate is perfect. Each country evaluates multiple factors like whether the country's economy is an industry driven economy or a service based economy, whether trade is in deficit or surplus consistently, is it a developing economy or a developed economy and then adopt a suitable rate.

Principle of Financial trinity - Also known as the impossible trinity or unholy trinity or monetary trilemma explains that a country cannot simultaneously achieve its 3 major goals which are - Free Capital Mobility, Fixed Exchange rate and Independent monetary policy.

To explain this principle there is an elaborate example

Assume that world interest rate is at 5%. If the home central bank tries to set domestic interest rate at a rate lower than 5%, for example at 2%, there will be a depreciation pressure on the home currency, because investors would want to sell their low yielding domestic currency and buy higher yielding foreign currency. If the central bank also wants to have free capital flows, the only way the central bank could prevent depreciation of the home currency is to sell its foreign currency reserves. Since foreign currency reserves of a central bank are limited, once the reserves are depleted, the domestic currency will depreciate.

Hence, all three of the policy objectives mentioned above cannot be pursued simultaneously. A central bank has to forgo one of the three objectives.

If 1$ from Rs. 80 moves to Rs. 85. $ is appreciated and Rs. is depreciated

If in the above example rupee is appreciated it will attract FPIs due to INR strengthening amplifying the returns when converted to INR from Dollar. It reduced inflation and negative impact on Indian export industry as the Indian goods become expensive in the international markets.

On the other hand, during Rupee depreciation exports will be pushed as the Indian goods become cheap for global buyers. It increases potential for FDI in the country as this situation is best suited for long term investments. Inflation is also expected to see a rise. Imports will effect Indian trade deficit adversely.

If inflation differential dominates, currency will depreciate faster as high inflation erodes the currency value. If capital flow of currency is higher than inflation differential then currency will appreciate due to increased foreign investments.

History of Rupee devaluation

1947-1966 - After independence Rupee was pegged to British pound until 1966, which held up $/INR rate to ₹4.67/$

1966-67 was a bad year for Indian economy as due to severe balance of payment crisis we had to devalue the rupee by 37% from ₹4.67/$ to ₹7.5/$. Slow economic growth and high reliance on imports led to persistent trade deficit situation.

1970-1980 - US invented the Bretton woods system and $ became a floating currency which was no longer hedged to gold or any commodity. India pegged INR to basket of currencies including dollar. The price of oil quadrupled from $3.00 to $12.00 per barrel due to the Arab-Israeli conflict of 1973,which further increased to $36.83 per barrel in 1979–1980 due to the Iranian revolution and the Iran-Iraq war. The oil price shocks increased India's import bill further weakening the rupee. During mid of 1981 ₹ touched near 9/$.

1981-1990- India relied heavily on external borrowings to finance its growth fiscal and trade deficit. Rupee steadily depreciated to ₹17/$ within the next 9 years on March 13, 1990.

1991-2000 - In 1991, India again faced severe balance of payment crisis, with forex reserves depleting to just 2 weeks worth of imports. Government was forced to adopt liberalization due to IMF and world bank pressures. Major factor which contributed to decline in rupee value were persistent trade deficit, rising inflation and capital account liberalization which led to forex rate volatility. Rupee devaluated from ₹17/$ to ₹40/$ at the start of early 2000.

2001-2007 - A good period for Rupee as it had started signaling appreciation. Liberalization scheme worked for India as with huge inflows of dollar in country investors preferred India and inflation also was low during this period.

2008 - Global crisis hit the world economy and crude oil prices went through the roof to $150/ barrel in march 2008. Due to rising crude oil prices $ forex reserves went out of developing economies and rupee started depreciating again.

2009-2020 - After 2008 inflation in India skyrocketed to double digits and thereon high inflation and trade deficits never gave Rupee a chance to recover and INR depreciated to ₹75/$ by early 2020.

After 2020 - Rupee has continued to depreciate at its historical average of 3% every year and recently made new lows of  ₹ 87.986/$ on Feb 10, 2025.