The rupee crashed to an all-time low of 86.71 against the dollar on Tuesday as sentiment around the domestic currency turned increasingly pessimistic. Since September last year, the rupee has depreciated by over 3.2%, with economists warning of further weakening. This development coincides with a significant downturn on Dalal Street, where market capitalisation has shrunk by Rs 60 trillion, or 12.6%, since the end of September 2024.
Market analysts note that the rupee breaching the psychological 86 mark occurred earlier than anticipated. It is now poised to touch 87 per dollar soon. The Reserve Bank of India has limited room to intervene, having already utilised a significant portion of its reserves. As of last week, India’s forex reserves stood at $634.6 billion, a decline of $70 billion from the September peak.
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The rupee’s depreciation is primarily driven by a robust dollar, bolstered by better-than-expected US jobs data that has reduced expectations of significant interest rate cuts by the Federal Reserve. Additional factors include rising crude oil prices and sustained foreign investor outflows. While the RBI has been praised for maintaining financial stability, forex dealers report that the central bank appears to have permitted the rupee’s gradual depreciation in recent weeks. Foreign investor sell-offs in equity markets have also exacerbated the rupee’s slide.
Should RBI intervene
The rupee’s recent depreciation has reignited the debate over exchange rate management. Historically, the RBI has prioritised exchange rate stability. However, experts argue that prolonged stability can mask underlying economic vulnerabilities and lead to sudden volatility. A more flexible exchange rate, they suggest, could act as a buffer against external shocks.
Exchange rate: Rupee vs Dollar
Excessive intervention to stabilise the rupee may distort market behaviour and overvalue the currency, leading to broader economic inefficiencies. A balanced approach, involving limited intervention to prevent extreme volatility while allowing greater flexibility, is increasingly being seen as a prudent policy choice.
Impact of rupee depreciation
Export gains and challenges: While a weaker rupee typically makes exports more competitive, this may not hold true in the current context. Structural inefficiencies and global economic headwinds have muted the impact of past rupee depreciations on export growth. Furthermore, key export sectors such as electronics, chemicals, petroleum, and engineering goods rely heavily on imported inputs, which become costlier when the rupee weakens. This offsets the competitive advantage of cheaper exports.
Import costs and consumer impact: Import-dependent sectors are bracing for significant cost pressures, which will likely be passed on to consumers. Automobiles, consumer durables, and travel-related expenses are expected to become more expensive. Airlines, in particular, face a crunch as their operating expenses are denominated in dollars, squeezing profit margins and potentially driving up ticket prices. The rising dollar also spells higher crude oil costs, further inflating India’s import bill. With India importing 80% of its crude oil, any hope of near-term fuel price reductions appears bleak.
Broader economic concerns: A depreciating rupee has added to concerns about India’s economic trajectory. While headline growth figures remain robust, signs of slowing rural demand and declining real incomes suggest underlying vulnerabilities. A stronger-than-expected US economy, coupled with potential policy shifts under a Trump administration, has strengthened the dollar, placing additional pressure on emerging market currencies, including the rupee.
China’s efforts to reduce dollar reserves and geopolitical uncertainties are reshaping the global economic landscape. For India, these external challenges are compounded by domestic issues such as slowing growth and rising rural distress. The RBI’s limited ability to ease monetary policy, given inflationary pressures and a stronger dollar, further narrows its options.
Policy recommendations
To address these challenges, experts suggest a strategic re-evaluation of India’s exchange rate policy. Allowing the rupee to depreciate further could alleviate pressure on the economy and attract capital inflows, such as NRI deposits, as seen in past episodes. However, this approach requires careful management to mitigate risks associated with inflation and ensure financial stability.
The new RBI governor faces a formidable task. Balancing the risks of greater exchange rate flexibility with the need to address underlying structural issues—such as weak growth and rising inflation—remains a critical challenge for India’s economic policymakers.
The rupee’s record low underscores the need for a nuanced approach to exchange rate management and broader economic policy. While short-term measures may provide relief, addressing structural vulnerabilities and fostering resilience against external shocks will be key to sustaining long-term economic stability.