What's Fundamentally Wrong
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). Increasing current account deficit, volatile domestic equity market, policy inaction, dependence on foreign money are some of the major causes contributing to rupee depreciation. Even though a lot of efforts have been put in by the RBI & Finance Ministry to control it, nothing seems to be working positively. Then what is going fundamentally wrong?
The first reason can be attributed to the Strained liquidity. The central banker's ability to intervene in the currency market remains strictly limited as we are running close to losing foreign currency reserves in terms of import cover. A sizable portion of external debt maturing over the next few months would require to be rolled over domestically, as global risk aversion would make the dollar availability limited and will in turn put pressure on the rupee liquidity. Any move by the RBI to support the rupee would put further pressure on the already strained liquidity. Along with all these factors mentioned above, unless we bring inflation under control and reduce the supply-side constraint, the rupee is expected to depreciate further against the dollar. The second one and at the core of the issue is the burgeoning Current Account Deficit [explained as imports over exports leading to a deficit] that makes India vulnerable to external shocks. And as one looks at the basket of goods imported, economists within the establishment somewhere down the line hold surging gold imports as the villain of the piece apart from oil and coal. For 2012-13 our gold import bill was $55 billion. This import creates huge pressure on the rupee as it converts precious foreign currency into gold. In the process, the government suffers from a double whammy. First gold import causes current account deficits and secondly, it is the cause and consequence of proliferation of unaccounted money within the national economy. Surely it is a gorilla in the room but yet to this date the Indian establishment would offer nothing concrete except to wish it away. And most important of all, How about governance? Thanks to a decade of mis-governance and policy paralysis at the Centre, production of even ordinary items has been stymied within India. That has compelled Indians to import when many items could be ordinarily produced or manufactured in India. India's overall external debt outstanding as of June-2013 was $390 billion, an increase of 12.9% per cent from last year. Additionally, a sizable portion of India's external debt is believed to be financed by European banks, which were the most active lenders to emerging Asia, much higher than the US or Japanese banks put together. Thus, with the ongoing re-capitalisation needs of European banks, it is likely that these banks will be less forthcoming in refinancing Indian corporate debt.
Allowing the depreciation of the rupee is as bad as surrendering our country to the force of the dollar, eventually forcing us to towards providing cheap labour and providing demographic dividends to other countries. Unless we control inflation and reduce the supply-side constraints, the rupee is expected to depreciate further against the dollar. We need to look into the source of saving from various small drops of foreign exchange to build required reserves.