Banking & Monetary Policy

Both depreciation and devaluation highlight an economic condition when there is a decrease in the value of the domestic currency in comparison to any other foreign currency, leading to a decline in the purchasing power of the domestic currency. However, the manner in which they occur is different. The differences between depreciation and devaluation are:

• Depreciation happens in the floating exchange rate regime, while devaluation is associated with the fixed/pegged exchange rate regime.
• Depreciation is a decrease in the value of domestic currency due to the market forces of demand and supply. Whereas, in the case of devaluation, the central bank deliberately makes downward adjustme:.t of the value of domestic currency vis-à-vis any other currency.
• Depreciation can occur on a daily basis, while devaluation is usually done occasionally by the central bank.

Some of the factors that affect the value of the Indian Rupee include:

• Market forces of demand and supply: The economic transaction of India with other countries creates demand for and supply of foreign exchange. When the demand for foreign currency is high, the exchange rate rises and the rupee depreciates. In contrast, if there is less demand for foreign currency, the exchange rate declines and rupee appreciates. It also depends on the demand and supply of Indian currency vis-à-vis other currencies.
• Intervention by the RBI: Sometimes, the RBI intervenes and influences the demand and supply of foreign exchange by buying and selling foreign currencies. For instance, when the RBI buys dollars, the supply of the dollar decreases, leading to increase in its price. This also leads to increase in the supply of rupee and decline in its value vis-à-vis the dollar.
• Currency speculation: Individuals/institutions buy foreign currency in the expectation that its value relative to rupee is going to increase in the near future. This expectation increases the demand for foreign currency and causes depreciation of the rupee.
• Interest rate differential between countries: High interest rate in India in comparison to other nations attracts foreign investors to invest in the Indian markets. It increases the demand for the Indian rupee, which leads to its appreciation.
• Income: When people’s disposable income in India increases, their spending on imported goods is likely to increase. This will increase the demand for foreign currencies and weaken the rupee.
• Price level: When the rate of inflation is higher in India than in other countries, purchasing power of the rupee declines, resulting in the reduction in its value in the international markets. Conversely, a low inflation rate will lead to appreciation of the rupee.

Any change in the value of the rupee has significant implications on the economy and policy making. Therefore, it requires careful maneuvering to manage macroeconomic indicators at optimum levels.