The rupee continued its downward trend, hitting an all-time low of 85.35 against the dollar in early trade on Friday. This marked the fourth consecutive session of depreciation, driven by a strong dollar and rising demand from importers. The local currency’s struggles were compounded by persistent foreign capital outflows, with foreign institutional investors offloading shares worth Rs 2,376.67 crore in the capital markets on Thursday.
On the domestic front, the rupee depreciation is accentuated by a widening trade deficit and a dipping economic growth rate. The currency has already declined 1.75% this quarter, reflecting broader economic challenges.
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Rupee outlook for 2025
Economists predict further weakening of the local currency. A limited rate cut cycle is likely to push the currency to 85.5 by the end of the financial year and possibly towards 86 or 86.50 by December 2025. The Reserve Bank of India’s intervention in the foreign exchange market is expected to be asymmetric — actively preventing sharp appreciation while allowing for gradual depreciation to rebuild foreign exchange reserves depleted during past interventions.
The RBI’s strategy also considers the depreciation of other major currencies, including the Chinese yuan. The dollar-rupee exchange rate could touch 86-86.50 due to a strong dollar index, high deficits, rising gold imports, and potential foreign portfolio outflows favouring China over India.
The real effective exchange rate (REER) of the rupee, which reflects the inflation-adjusted, trade-weighted average value of a currency against its trading partners, appreciated to 108.14 in November from 107.20 in October, marking a 0.9% increase, according to a report authored by Reserve Bank of India staff. This nominal appreciation outweighed the unfavourable price differences, showcasing the rupee’s relative stability despite global headwinds.
Emerging market currencies faced significant pressure in November due to foreign portfolio outflows, a strengthening dollar, and rising US yields, but the rupee’s modest 0.4% depreciation against the dollar demonstrated its resilience. Moreover, the rupee recorded the lowest volatility among major currencies, reinforcing its comparative strength amidst heightened global uncertainties.
Impact of a strong dollar
The dollar remains well-supported ahead of Donald Trump’s inauguration as US president in January 2025. His anticipated policies, likely to spur inflation and growth, are driving up US Treasury yields and strengthening the greenback. The dollar index has appreciated by more than 7% this quarter, staying firmly above the 108 level. This robust dollar performance continues to exert pressure on the rupee and other Asian currencies. Despite these challenges, the Indian rupee has shown relative resilience compared with its peers, aided by proactive RBI interventions.
The rupee depreciation could add $15 billion to India’s aggregate import bill if external factors remain unchanged. Although low oil prices in the near term may mitigate the impact on energy costs, other import-dependent sectors are at risk.
India’s reliance on imports for edible oils and pulses makes these commodities particularly vulnerable. The country imports 58% of its edible oil needs and 15-20% of its pulses consumption, with rising costs potentially straining food security. Higher prices for imported fertilisers such as urea and DAP could also have significant fiscal implications.
Industrial imports, particularly from China, are another major concern. India imports $100 billion-worth of industrial goods annually from China, and sectors like electronics — where 80–90% of smartphone components are imported — may face higher prices.
India’s dependence on imported coal for thermal power and steel production adds another layer of vulnerability. For every rupee fluctuation, the cost of electricity generation from coal-based projects changes by 4 paise per unit, potentially impacting 75% of India’s total electricity generation.
Managing rupee volatility
The Reserve Bank of India needs a delicate balancing act as it seeks to maintain currency stability while addressing broader economic challenges. Analysts argue that the RBI should consider allowing the rupee to depreciate gradually, as this approach would:
Enhance export competitiveness: A weaker rupee would make Indian exports more attractive on the global stage.
Increase monetary flexibility: By focusing less on currency intervention, the RBI could redirect resources toward addressing domestic economic concerns.
Avoid disruptive adjustments: Gradual rupee depreciation minimises the risk of sudden and disruptive corrections in the currency market.
The rupee’s trajectory will depend on global economic trends, India’s growth prospects, and the broader outlook for emerging markets. Countries like China, Brazil, and South Africa are also grappling with economic vulnerabilities, and geopolitical developments could further influence the rupee’s path.
The policymakers face a challenging environment, with external pressures and domestic vulnerabilities weighing on the rupee. While currency interventions may offer short-term relief, a strategic focus on gradual depreciation and enhanced export competitiveness will be essential to navigating the road ahead. By adopting this approach, the RBI can build resilience into the economy while minimising risks associated with external shocks.