Reaching unprecedented lows recently, the Indian rupee has been consistently devalued against the US dollar.
Policymakers and people in many spheres of life are worried about this tendency. The fall of the rupee has resulted from a mix of internal economic difficulties and outside world events.
To appreciate the larger economic picture and the consequences for India’s economy, one must first understand these elements.
Gaining Knowledge on Rupee Depreciation
The value of a nation’s currency captures its global investor confidence and state of economic vitality. The Indian rupee has been under great downward pressure lately.
Reflecting a significant downturn, the rupee had crossed the 85-mark against the US dollar by December 2024.
India’s rising trade deficit, foreign investment outflows, and US economic strength all play a part in this decline. Furthermore, although meant to stabilize the rupee, the Reserve Bank of India’s (RBI) actions have had inconsistent results.
1. Trade imbalance in India: Main cause of depreciating value
The trade imbalance of India is one of the main causes of the rupee’s devaluation. A trade imbalance is the result of a nation importing more than it exports, therefore mismatching the demand for foreign currencies with the supply of domestic money.
India mostly depends on imports of gold, electronics, and crude oil—two basic needs. Since these items are mostly exchanged in US dollars, a larger import bill drives demand for dollars while devalues the value of the rupee.
Rising from $27 billion in October, India’s merchandise trade deficit in November 2024 increased to a record-breaking $37.8 billion.
Rising world oil prices and a boom in consumer demand for imported items drove this extreme growth in the trade deficit. On the other hand, logistical difficulties and declining worldwide demand have made India’s exports slow to keep up.
Why Does the Rupee Get Weak from a Trade Deficit?
Indian companies buying international products have to translate rupees into dollars, hence driving demand for US dollars.
The rupee depresses if this demand exceeds the export inflow of dollars. The ongoing trade deficit has magnified this impact and continuously devalued the value of the rupee.
2. Foreign Investment Outflows: Rupee Weakens Under Capital Flight
The flood of foreign investors is another main reason the rupee depreciated. Maintaining currency stability depends much on foreign institutional investors (FIIs).
Investing in Indian equities and bonds brings US money, therefore raising the value of the rupee. On the other hand, the demand for rupees decreases and its value decreases when one withdraws money.
Rising interest rates in wealthy economies and global economic instability in 2024 caused international investors to cut their exposure to rising markets including India.
India saw net outflows of more than $1 billion by August 2024, a dramatic departure from the $22 billion inflow noted year-before.
Several things set off this capital exodus:
Higher US Interest Rates: US Treasury bonds become more appealing to foreign investors as the Federal Reserve boosted interest rates to fight inflation.
This caused a movement of capital from developing countries toward safer, more highly yielding assets.
Global geopolitical uncertainties, including wars in Eastern Europe and the Middle East, further raised investor inclination for safe-haven currencies like the US dollar.
Slower-than-expected GDP growth and ongoing inflation in India caused questions among foreign investors about home development, which resulted in capital withdrawals.
3. Managing the slide of the Rupee: RBI Intervention
The Reserve Bank of India (RBI) actively entered the foreign exchange market in an effort to slow down the depreciuation of the rupee. The RBI sold around $40 billion from its foreign exchange reserves between October and December 2024 to help to stabilize the value of the currency.
How Does RBI Intervention Function?
The RBI opens the market selling US dollars when the rupee depreciates noticeably. This raises demand for the rupee and increases the dollar supply, therefore momentarily stabilizing their value.
Though this approach can offer temporary respite, it also runs down India’s foreign exchange reserves.
India’s foreign exchange reserves dropped to $570 billion as of December 2024, a notable decline from its $640 billion peak in 2022. Should the reserves keep falling, the RBI’s capacity for timely intervention could be restricted, therefore compromising future monetary stability.
4. The Global Force of US Economic Strength
External events outside of India’s grasp also affect the value of the rupee. The US dollar is more expensive than other currencies since the relative strength of the US economy has raised world demand for it.
With solid employment growth, lowering inflation, and high consumer expenditure, the US economy exhibited resiliency against world concerns by late 2024.
Higher interest rates and this economic vitality drew worldwide capital to the US, therefore strengthening the dollar against other currencies like the rupee.
Why Does a strong dollar weaken the rupee?
Appreciating US dollars increases the cost of imports and foreign borrowing for other nations. For India, this means more costly foreign loan repayments and increased prices for basic commodities like oil, hence aggravating the devaluation of the rupee.
Effects of the Rupee’s Decline
The declining rupee has broad effects on India’s people and economy:
A devalued rupee causes imports to be more costly, which raises the prices of basic commodities including drugs, electronics, and gasoline. This lowers consumers’ buying power and helps to explain more general inflation.
India’s external debt, denominated in US dollars, becomes more costly to service, therefore burdening government and business debtors.
Constant RBI intervention to stabilizing the rupee degrades foreign exchange reserves, therefore lowering the nation’s financial buffer against future economic shocks.
Businesses depending on imported raw materials must pay more, which might lower profit margins and competitiveness. On the other hand, export-oriented industries could gain from a devaluation of the rupee if their products get less expensive worldwide markets.
Strategies to Minimise Depreciation of the Rupee
Although several elements drive the devaluation of the rupee, numerous steps might assist stabilize the value and boost the economy:
Policies supporting home production and less reliance on imports help to close the trade deficit. Projects like “Make in India” can help local industry grow and raise export appeal.
Implementing investor-friendly policies and enhancing the simplicity of conducting business will help to draw and keep foreign capital, hence strengthening the rupee.
Through sovereign bonds, diversifying reserve assets and raising foreign currency holdings will help the RBI better control currency volatility.
Fiscal discipline, good monetary policy, and structural reforms can help to guarantee long-term currency stability and boost investor confidence and so strengthening financial stability.
The drop of the Indian rupee against the US dollar shows the junction of internal and international problems. Although the RBI’s actions offer temporary respite, addressing the underlying causes—like the trade deficit and capital outflows—requires all-encompassing policy changes.
Stabilizing the rupee and guaranteeing long-term economic resilience would depend mostly on strengthening the home economy, boosting investor confidence, and keeping strong foreign exchange reserves.
