 "Illustration by Ajaya Mohanty")
Foreign capital inflows finance the gap between investment and savings. The exchange rate is the price that adjusts to ensure that the capital inflow is exactly as large as is required. An important part of the capital flows into India is debt flows. When the perceived credit risk of borrowing entities worsens, overseas debt investors become uncomfortable, and there is a shortfall of inbound capital. Rupee depreciation makes Indian assets more attractive, and compensates for deterioration in domestic credit quality.
One of the great insights of macroeconomics is the idea that the current account deficit (which we normally think of
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