By Vipul Tamhane
In the ever-evolving landscape of global finance, the Indian rupee's decline against the US dollar has become a focal point of discussion among economists, policymakers, and the general public. Headlines often scream about the rupee's free fall, invoking a sense of crisis and urgency. However, a closer examination reveals that this narrative may be more sensational than substantive. The rupee's depreciation is not a new phenomenon; rather, it is a continuation of a long-standing trend shaped by historical, economic, and political factors.
The historical context
To grasp the current state of the Indian rupee against the dollar, it is essential to explore its historical context.
(Graph courtesy of the author)
The devaluation of the Indian rupee against the US dollar is a complex issue shaped by historical and economic factors. Initially, during the pre-independence era, the rupee's value was closely tied to British economic conditions. After gaining independence in 1947, the rupee was valued at approximately 3.30 against the dollar, influenced by the British pound.
From 1950 to the mid-1990s, the rupee maintained a relatively stable value, but geopolitical tensions, such as the India-China and India-Pakistan wars, along with economic crises, led to significant depreciation. By the early 1990s, the rupee had dropped to ₹17.50 per dollar. The pivotal moment came in 1991 when Dr Manmohan Singh initiated major devaluations, shifting towards a market-driven currency valuation. Since then the rupee has steadily declined against the dollar, experiencing an overall depreciation of about 231% from 1992 to the present. This translates to a compounded annual growth rate (CAGR) of approximately 3.58%, with the decline remaining consistent and devoid of dramatic fluctuations that might suggest a crisis.
The steady decline
The performance of the Indian rupee over the decades reveals a consistent pattern of decline. From 1992 to 2002, the rupee steadily depreciated despite significant political and economic upheavals, including government changes and international sanctions. This trend continued into the 21st century, with the rupee starting at around ₹47 per dollar in 2001 and reaching approximately ₹83 by 2023.
Factors such as a growing current account deficit and high oil import costs have perpetuated this depreciation. Although the rupee began to stabilize after 2002, bolstered by economic reforms and a burgeoning services sector, the narrative of a falling rupee persisted, often fueled by political rhetoric.
Ironically, the Indian political and economic landscape has become so accustomed to a declining rupee that any signs of stabilization are met with skepticism. This "currency nationalism" can cloud rational economic analysis, leading to a normalization of the rupee's decline and making fluctuations appear routine rather than alarming.
Why is the rupee sliding?
The primary reason behind a weakening rupee is the strengthening of the US dollar amid an improved macroeconomic scenario in the US. Additionally, a spike in US bond yields due to expectations of shallow rate cuts by the US Federal Reserve has made the US more attractive to investors relative to emerging markets like India. Uncertainty regarding new US government policies has also contributed to the rupee's fall.
Oil price volatility due to ongoing geopolitical tensions, such as the Russia-Ukraine war, the Middle East crisis, and substantial foreign portfolio investment (FPI) outflows in equity markets have also played a significant role in the rupee's decline. Despite the slide, the rupee has remained among the world’s most stable currencies.
"To date, the rupee has depreciated by nearly 3% against the US dollar, still in the lowest echelon when compared with other countries," an SBI report stated. The stability earlier in the first half of 2024 was attributed to capital inflows driven by the inclusion of Indian bonds in global bond indices, which cushioned the rupee against greater volatility.
How does a weak rupee affect the economy?
A weak rupee significantly impacts India's economy by increasing the import bill, as importers must pay in dollars. This rise in costs affects essential commodities like edible oils, pulses, fertilizers, and particularly oil and gas, with India relying on crude oil for nearly 88% of its needs. Consequently, a weaker rupee leads to higher import expenses, driving inflation upward. For instance, increased oil prices elevate transport costs, making food items more expensive.
This higher import bill exacerbates the trade deficit and dampens economic growth by putting upward pressure on interest rates. However, export-centric sectors such as pharmaceuticals, textiles, and IT may benefit from improved revenues in rupee terms, as a weaker rupee makes their products more competitive abroad.
Conversely, import-dependent sectors like energy, electronics, and transportation face negative repercussions. Companies with overseas debt will see increased servicing costs, while students studying abroad and Indian travelers will pay more due to the rupee's decline. This inflationary pressure complicates the Reserve Bank of India's efforts to control prices and diminishes the likelihood of anticipated rate cuts amid a recent slump in GDP growth.
The current situation
As the Indian rupee continues to weaken, analysts are raising alarms about its trajectory. Research indicates that the rupee has depreciated by approximately 3% in 2024, yet it has still outperformed many other emerging market currencies. Despite this relative strength, the narrative of crisis persists. The Reserve Bank of India (RBI) has intervened in the currency market, spending around $50 billion to support the rupee, but this effort has faced challenges.
The RBI's reserves have been impacted by the revaluation of other currencies, placing the central bank in a precarious position. With the dollar gaining strength ahead of the US presidential inauguration, analysts suggest that the RBI may need to loosen its grip on the rupee in 2025. The substantial forex intervention since October has led to tighter banking liquidity and higher short-term rates, contributing to capital outflows and potential dollar hoarding. Experts argue that allowing some depreciation could be a prudent strategy, as the RBI aims to manage currency volatility amid strong global headwinds.
What's the outlook for the rupee?
The Indian rupee is on track to fall past 90 per dollar this year, with analysts from Gavekal Research predicting a potential decline of around 10%, possibly pushing the currency to 95. Recent weeks have seen the rupee hit record lows, prompting speculation about the Reserve Bank of India (RBI) loosening its grip under new Governor Sanjay Malhotra, a shift from the previous administration's quasi-peg strategy.
The rupee's decline is driven by several factors, including the rise of Donald Trump, foreign portfolio investment (FPI) pullouts, and escalating oil prices. A report from the State Bank of India refers to these fluctuations as the "Trump Tantrum," suggesting that while initial turbulence may occur during Trump's second term, stabilization is anticipated afterward. Historically, the rupee has fared better under Republican administrations, indicating increased vulnerability under a Democratic regime. As the rupee continues to reach lifetime lows, pressure from a stronger dollar and inconsistent FPI inflows is expected to persist, challenging the currency's stability.
Not alarming
Despite recent fluctuations, the decline of the Indian rupee is not a new phenomenon. This trend has persisted for decades, driven by economic factors such as inflation differentials and current account deficits. While market sentiment can influence short-term movements, the long-term trajectory of the rupee remains largely unchanged.
The narrative surrounding the rupee's fall against the dollar is often exaggerated, fueled by political agendas and media sensationalism. In reality, the rupee's decline has been steady and predictable, shaped by historical, economic, and political contexts. As we navigate the complexities of the global economy, it is crucial to understand that these fluctuations are part of a broader economic landscape.
In conclusion, while headlines may proclaim a crisis, the rupee's situation is a familiar story, one that reflects the underlying economic realities of India and the world. The markets operate independently of nationalism, and the rupee's value will continue to mirror these fundamental economic conditions.
