Answer:

[Student Note: The answer has been kept long to discuss all points of the issue in detail at one place. Write down a summary within word limit for your answer]

Causes of Rupee Depreciation:

♤ Appreciation in the US dollar: Since the United States Federal Reserve hinted at exiting from Quantitative Easing (QE) in May 2013, the currencies of several emerging markets have been affected. Since then, the Indian Rupee has depreciated 22% against the US dollar. The easy money ensured that US funds moved to emerging markets like India in search of high yields. So, as the Fed tapers off its bond-purchasing program, and with US interest rates rising, the belief is that fund inflows to countries like India will also slow down.

♤ Large Current Account deficit: Depreciation is also a highly visible symptom of a much deeper economic malaise represented by the burgeoning current account deficit (CAD), which, at over $90 billion, threatens macroeconomic stability.

♤ Weakening capital inflows: Capital inflows have reduced due to the improving economic situation in the US and other developed countries. The prospect of the Federal Reserve’s ultra-soft monetary policy ending has already raised bond yields

there. As in other countries, the Indian bond market has also seen withdrawals by foreign institutional investors (FIIs) in the past few weeks. With a risk-off environment setting in globally, there have been redemptions from global exchange-traded funds (ETFs). This has led to selling by FIIs in the Indian equity market, compounding the rupee's woes.

♤ Inflation: Part of the depreciation is attributable to the adjustment of the rupee exchange rate to the inflation differential, i.e. India’s relatively high rate of inflation versus other economies.