Rupee in Retreat: Factors Fueling India’s Currency Slide

In 2024, the Indian rupee depreciated by approximately 3%, reaching a low of around 85.80 per US dollar, and marking a 20% decline over the last five years. This ongoing trend highlights concerns about its underlying dynamics and future implications. To understand the rupee’s depreciation, analysing the contributing factors and exploring potential solutions is essential.

Factors Behind Rupee Depreciation

1. Demand-Supply Mismatch: The rupee weakens when the demand for US dollars surpasses supply. This often happens due to higher imports, necessitating more dollar purchases to settle trade balances. Conversely, a drop in foreign investment inflows further reduces the dollar supply.
2. Current Account Deficit (CAD): A persistent CAD signals that India imports more goods and services than it exports, increasing reliance on foreign currency reserves. In 2024, India’s CAD remained elevated due to rising crude oil prices and higher import volumes.
3. Inflation Differential: India’s higher inflation rates compared to its trading partners erode the rupee’s purchasing power, making it less attractive in global markets.
4. Economic Growth Trends: Slower-than-expected GDP growth undermines investor confidence in the rupee. This was evident during periods of subdued economic activity over the past five years.
5. US Interest Rates: The US Federal Reserve’s tightening monetary policy has attracted global capital to dollar-denominated assets, strengthening the dollar while weakening emerging market currencies like the rupee.
6. Geopolitical and Global Crises: Events such as geopolitical tensions or global economic uncertainties often drive investors to the US dollar, considered a safe-haven currency. Such crises disproportionately impact emerging market currencies.
7. Speculative Trading and Sentiment: Market perceptions and speculative trading exacerbate currency volatility. A weakening rupee can trigger further depreciation if traders anticipate continued downward pressure.

Possibilities and Strategies to Stabilize the Rupee

1. Boosting Exports: Strengthening export sectors through incentives and trade agreements can enhance dollar inflows and narrow the trade deficit.
2. Attracting Foreign Investment: Simplifying regulatory frameworks and improving ease of doing business can encourage foreign direct and portfolio investments, increasing dollar availability.
3. Managing Inflation: A concerted effort to control inflation through monetary and fiscal measures can help stabilize the rupee’s value over time.
4. Strengthening Domestic Production: Reducing import dependence by promoting domestic manufacturing under initiatives like “Make in India” can alleviate pressure on the rupee.
5. Diversifying Forex Reserves: Investing in a balanced mix of global currencies and assets can shield India’s reserves from excessive reliance on the US dollar.
6. Policy Alignment with Global Trends: Aligning monetary and fiscal policies with global economic trends can mitigate external shocks. Transparent communication from policymakers can also help anchor market expectations.
7. Leveraging Technology: Implementing blockchain and AI-driven systems in currency management can enhance efficiency in forex operations and reduce speculative pressures.

Conclusion

The rupee’s depreciation reflects a complex interplay of domestic and global factors. While short-term fluctuations are inevitable, India’s long-term currency stability depends on structural reforms, effective policy interventions, and consistent efforts to enhance economic resilience. By addressing these challenges, India can pave the way for a stronger rupee and a more robust economic foundation.