A brief history of the Indian rupee
At the time of independence, the Indian currency was never measured against the dollar. Instead, it was measured against the pound. When in 1949, the pound was devalued, the rupee was started measuring against the dollar; and this is the trend that continues to date.
Interestingly, while rate/ dollar in Indian rupees in 1949 was just 4.76, it stands at 75.65 today!
Before delving into analysis further, it is imperative to understand a few terms.
Inflation refers to an increase in prices and a decline in the purchasing value of money.
A trade deficit is a measure of the excess of the country’s imports over its exports. That is, the trade deficit equals the total value of imports minus the total value of exports.
India continues to have more imports than exports, and to make import bill payments, it needs a huge forex reserve. The rapid rise in imports as compared to our exports has led to the situation of a trade deficit.
As per the latest data, both imports and exports have fallen due to the coronavirus pandemic; since demand all over the globe has been affected.
For the first time in all of human history, crude oil prices have fallen to 0 USD per barrel, and are now entering the negative zone. Falling crude prices are good for developing economies, which need to import crude oil for their domestic consumption.
Let us try and understand how the Indian economy can benefit from these falling crude oil prices.
The entire global economy is at a standstill. There are travel restrictions everywhere. Consequently, there is a reduced demand for crude oil in the international market. This minimal consumption and lack of storage space have led to a fall in crude oil prices.
Also, India happens to be the third-largest crude oil and petroleum product importer in the world. Of all Indian imports, crude oil and related products make for 27% of the total value. Moreover, the country is importing 82% of its domestic crude oil requirement.
In 2019, import bills for crude oil totaled $102.3 billion. This is when the average price for the same was $57.00/barrel. Ever since the outbreak, the prices have fallen drastically to as low as $25.88/barrel. This means that India will see lesser outflows of foreign reserves for purchasing crude oil, which will then reduce inflation. It is estimated that the country will be able to save around INR 3,40,200 crores in the current financial year as a result of this fall in prices.
Impact on inflation
Most industries rely heavily on oils and petrochemicals as an important raw material for their manufacturing. Additionally, oil is an important fuel for transportation. When the prices of crude oil have fallen, this then also means that the cost of production will go down. This benefit will then pass on to the end consumers since inflation will be reduced. Ultimately, the consumer will have to pay less to purchase the same good.
Impact on Dollar v/s Rupees
In the international market, crude oil is traded in dollars. It is known as petrodollar, and bills for imports are settled in dollars only. India, therefore, needs huge amounts of foreign exchange reserves to clear its import payments. And because the country is constantly facing a trade deficit, it needs to look for ways to reduce its trade deficit. This naturally leads to inflation in the country.
A high deficit means that the country has to sell rupees and buy dollars to pay its bills. Ever since the crude oil prices have fallen, India now has to shell out less money to buy crude oil. Saving on its foreign exchange reserves has strengthened the value of the rupee in the international market, and has helped to curb inflation.
It is no doubt that the COVID 19 situation has hit the entire global economy. However, falling crude oil prices are a boon for the Indian economy. If prices continue to remain low over extended periods, the economy will probably be able to offset the impact of the virus.