Introduction
The Indian rupee continues to face a downward spiral, recently hitting a record low of ₹85.83 against the U.S. dollar on January 8, 2025. In 2024 alone, the rupee depreciated by 3%, driven by various factors such as foreign investor exits, a widening trade deficit, and global economic uncertainties. This article explores the reasons behind the rupee’s weakening, its impact on the Indian economy, and potential solutions to stabilize the currency.
Context:
- In the last week of December 2024, the rupee dropped below 85 against the U.S. dollar, hitting a new low of 85.81.
- In 2024 alone, the rupee fell by about 3%.
- Today (08 Jan 2025), the rupee depreciated 9 paise to hit its record low of 85.83 against the U.S. dollar in early trade.
Why rupees falling:
- Exit of foreign investors:
- a. In the first 3 days of January, 2025, FPIs have pulled Rs 4,285 crore from Indian equities.
- b. In 2024, FPIs pulled out more than 1.55 lakh crore from Indian stock market.
- c. Leading to increased selling pressure on the rupees.
- Widening Trade Deficit:
- India’s trade deficit has widened due to high imports, particularly of crude oil and gold, compared to its exports.
- India’s trade deficit from April to October 2024 was $164 billion which was higher than $149 billion in the same period in 2023.
- This increased demand for foreign currencies (like the U.S. dollar) to pay for these imports has contributed to the rupee’s weakening.
- Monetary Policy Differences:
- The Reserve Bank of India’s relatively looser monetary policy compared to the U.S. Federal Reserve.
- This has resulted in higher inflation rates in India.
- This inflation differential makes Indian assets less attractive to foreign investors, further reducing demand for the rupee.
- The Reserve Bank of India’s relatively looser monetary policy compared to the U.S. Federal Reserve.
- Global Economic Factors:
- Geopolitical tensions, such as
- The Russia-Ukraine war and destabilization in the Middle East.
- Rising global crude oil prices, have created volatility in the markets, leading to capital outflows from emerging markets like India.
- US own current position
- a. Strengthening of US Dollar.
- b. Higher US bond yields.
- Has made investment in the US more attractive compared to India.
- Geopolitical tensions, such as
Impact of Rupee depreciation?
- Increased Import Costs:
- A weaker rupee raises the cost of imports, particularly for essential goods such as crude oil, fertilizers, and edible oils.
- This increase in import bills can lead to a higher overall trade deficit, which reached an all-time high of $37.8 billion in November 2024, exacerbating economic vulnerabilities.
- Inflationary Pressures:
- The rising costs of imported goods contribute to inflation, making everyday goods more expensive for consumers.
- This can lead to higher living costs and reduced purchasing power, as seen with the increased prices of food and fuel due to higher import expenses.
- Impact on Economic Growth:
- The combination of rising inflation and increased costs can dampen economic growth.
- Higher import bills can create upward pressure on interest rates, making borrowing more expensive and potentially slowing down investment and consumption.
What RBI should do?
| Stabilizing Currency Value | Preventing Inflationary Pressures | Maintaining Investor Confidence |
Way Forward:
| Diversify Export Markets | Reduce Dependence on Imports | Monetary Policy Coordination and Strengthening Fundamentals |
Conclusion
The depreciation of the Indian rupee highlights the need for a multifaceted approach to strengthen the currency. By stabilizing monetary policies, reducing import dependencies, and encouraging diversified export markets, India can mitigate the adverse effects of a weakening rupee. Strategic economic reforms and consistent efforts by the Reserve Bank of India (RBI) will be critical in safeguarding the economy from further vulnerabilities while maintaining investor confidence and long-term growth.
