Why is the depreciation of the rupee not stopping ?

Dr Satyawan Saurabh *

A widening trade deficit due to a rise in imports compared to exports leads to foreign exchange outflows, weakening the rupee. India's record trade deficit in 2022 due to rising crude oil and gold imports drives rupee depreciation. The fall in the Indian rupee underscores the challenges of maintaining currency stability amid external sector vulnerabilities.

Currency fluctuations are triggered by global geopolitical tensions such as the Russia-Ukraine war, rising crude oil prices, and capital outflows, as well as domestic factors such as the fiscal deficit. Effective policy measures are crucial to enhance India's external resilience and stabilize its economy.

Sustained outflows after the September 2024 stock peak weakened the rupee as investors moved to safer assets amid speculation of a rise in US interest rates. Trade deficits, such as the high trade deficit, highlight external dependence on imports, especially for energy, widening the current account deficit during rupee weakness. India's crude oil import bill rose with the rupee depreciation, widening the 2024 trade deficit to close to $75 billion.

Global events such as tariff threats and the BRICS currency dispute add to volatility by creating uncertainties for India's external trade and investment. The US President's 2024 tariff warning against the currency plans of the BRICS countries triggered a market sell-off, weakening India's external stability. Heavy reliance on foreign exchange reserves to stabilize the rupee restricts long-term monetary flexibility during sustained global market turmoil.

The rupee exhausted more than $20 billion in reserves in a single quarter to pull the rupee back to 85.53 in December 2024. A weak rupee constrains domestic monetary policies, raising inflation through costlier imports while reducing fiscal space to address growth concerns. The cost of crude oil imports rose 15% in December 2024, putting pressure on policymakers to effectively balance currency management and fiscal expansion strategies.

Protectionist trade measures, such as tariffs or sanctions, can undermine currency stability by disrupting the trade balance. Political instability or conflict between major economies creates volatility, boosting demand for the safe-haven dollar and weakening emerging market currencies. The Russia-Ukraine war led to a surge in global crude oil prices, which put pressure on India's import bill and depreciated the rupee.

Tight monetary policies in advanced economies lead to capital outflows from India, putting pressure on the rupee. The US Federal Reserve's rate hike plan in 2022-23 led to foreign portfolio outflows, which weakened the rupee.

A widening trade deficit due to a rise in imports compared to exports leads to foreign exchange outflows, weakening the rupee. India's record trade deficit in 2022 due to rising crude oil and gold imports drives rupee depreciation. High domestic inflation depreciates the currency value, making exports less competitive and imports costlier.

Rising prices of inelastic imports such as crude oil push up India's import bills, weakening the rupee in 2023. A decline in domestic and foreign investment indicates weak economic growth, discouraging currency inflows. In 2024, declining corporate performance and rising stock valuations led to foreign portfolio investment outflows.

Central bank interventions to stabilize the currency are limited by foreign exchange reserves and can provide only temporary relief. A late RBI intervention in December 2024 managed to temporarily stabilize the rupee at 85.53 per dollar. A fiscally constrained government reduces its ability to manage external shocks, thereby weakening confidence in currency stability.

India's record fiscal deficit during the pandemic limited government measures to boost external resilience. The government's clear stance on currency policies boosts investor confidence and reduces speculative pressure. The RBI governor's ruling out of de-dollarization in 2024 reassured the market, temporarily easing concerns of rupee depreciation.

Measures to strengthen external resilience include boosting exports and focusing on value-added manufacturing and services to increase foreign exchange earnings and reduce trade imbalances. Strengthening sectors such as pharmaceuticals and IT can help reduce the trade deficit and stabilize the rupee. Reduce dependence on volatile crude oil and essential imports by entering into long-term agreements with diversified suppliers.

Expanding crude oil imports from Russia and Middle Eastern countries reduces average oil import costs in 2023. Build strong reserves through sovereign wealth funds and gold accumulation for effective currency stabilization.

According to the Reserve Bank, record foreign exchange reserves of $600 billion in 2021 helped manage volatility during the pandemic. Enter into agreements to settle trade in local currencies, reducing dependence on the US dollar and mitigating exchange rate risks.

The India-Russia Rupee-Ruble Trading Mechanism eased pressure on foreign exchange reserves during the Russia-Ukraine crisis. Prioritize low-cost and long-term borrowings while reducing short-term external debt to avoid currency risks.

India's increased issuance of sovereign green bonds helped attract stable foreign investment while reducing repayment volatility in 2023. A strong external sector is important for India's economic resilience amid global uncertainties.

By promoting export competitiveness, ensuring prudent fiscal policy, diversifying foreign exchange reserves, and increasing bilateral trade in rupees, India can reduce currency volatility. A visionary strategy emphasizing structural reforms and global economic integration will ensure long-term stability and strengthen India's position in the global economy.