Answer

The depreciation of the Indian rupee underscores the challenges in maintaining currency stability amidst external sector vulnerabilities. Currency value fluctuations arise from global geopolitical tensions like the Russia-Ukraine war, rising crude oil prices, and capital outflows, alongside domestic factors like fiscal deficits. Effective policy measures are crucial to enhance India’s external resilience and stabilize its economy.

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The recent rupee depreciation highlights India’s external sector vulnerabilities

• Global Portfolio Outflows: Depreciation reflects the vulnerability of reliance on foreign portfolio investments, which retreat during global financial uncertainties.
  For example: Sustained outflows post-September 2024’s stock peak weakened the rupee as investors moved to safer assets amidst U.S. interest rate hike speculations.
• Trade Deficits: High trade deficits highlight external dependency on imports, especially for energy, increasing current account deficit during rupee weakness.
  For example: India’s import bill for crude oil surged with rupee depreciation, exacerbating the Q4 2024 trade deficit, nearing $75 billion.
• Geopolitical Risks: Global events, like tariff threats and BRICS currency debates, amplify instability by creating uncertainties for India’s external trade and investments.
  For example: The U.S. President’s 2024 tariff warning against BRICS nations’ currency plans prompted market sell-offs, weakening India’s external stability.
• Foreign Reserve Limitations: Heavy reliance on forex reserves for stabilizing the rupee restricts long-term monetary flexibility during sustained global market turbulence.
  For example: RBI intervention in December 2024 to pull the rupee back to 85.53 exhausted reserves by over $20 billion in a single quarter.
• Policy Challenges: Weak rupee restricts domestic monetary policies, aggravating inflation through costly imports while reducing fiscal space for addressing growth concerns.
  For example: December 2024 crude oil import costs rose 15%, pressuring policymakers to balance currency management and fiscal expansion strategies effectively.

Factors Affecting India’s currency stability

Global Geopolitics: Impact on Currency Stability

• Trade Policies: Protectionist trade measures, such as tariffs or sanctions, can weaken currency stability by disrupting trade balances.
• Geopolitical Tensions: Political instability or conflicts among major economies create volatility, driving safe-haven dollar demand and weakening emerging market currencies.
  For example: The Russia-Ukraine war caused a surge in global crude prices, straining India’s import bill and depreciating the rupee.
• Global Monetary Policies: Tightening monetary policies in advanced economies attract capital outflows from India, pressuring the rupee.
  For example: The US Federal Reserve’s rate hikes in 2022-23 led to foreign portfolio outflows, weakening the rupee.

Domestic Economic Indicators: Impact on Currency Stability

• Trade Deficits: A widening trade deficit due to higher imports over exports increases foreign exchange outflows, weakening the rupee.
  For example: India’s record trade deficit in 2022 due to rising crude and gold imports intensified rupee depreciation.
• Inflation: High domestic inflation reduces currency value, making exports less competitive and imports costlier.
  For example: Rising prices of inelastic imports like crude oil inflated India’s import bills, weakening the rupee in 2023.
• Investment Trends: Declining domestic and foreign investments signal weak economic growth, discouraging currency inflows.
  For example: In 2024, subdued corporate performance and overstretched stock valuations led to foreign portfolio investment outflows.

Policy Responses: Impact on Currency Stability

• Forex Interventions: Central bank interventions to stabilize the currency are limited by forex reserves and can only offer temporary relief.
  For example: The RBI’s late intervention in December 2024 managed to stabilize the rupee temporarily at 85.53 per dollar.
• Fiscal Policy: A fiscally constrained government reduces its ability to manage external shocks, weakening confidence in currency stability.
  For example: India’s record fiscal deficit during the pandemic limited government measures to boost external resilience.
• Communication Strategy: Clear government stance on currency policies builds investor confidence and reduces speculative pressures.
  For example: The RBI governor’s dismissal of de-dollarization in 2024 reassured markets, temporarily easing rupee depreciation concerns.

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Measures to Strengthen External Resilience

• Boost Exports: Focus on value-added manufacturing and services to increase foreign exchange earnings and reduce trade imbalances.
  For example: Strengthening sectors like pharmaceuticals and IT can help mitigate trade deficits and stabilize the rupee.
• Diversify Import Sources: Reduce dependency on volatile crude and essential imports by securing long-term agreements with diverse suppliers.
  For example: Expanding crude imports from Russia and Middle Eastern countries lowered average oil import costs in 2023.
• Expand Forex Reserves: Build stronger reserves through sovereign wealth funds and gold accumulation for effective currency stabilization.
  For example: The RBI’s record forex reserves of $600 billion in 2021 helped manage volatility during the pandemic.
• Promote Bilateral Trade in Local Currencies: Engage in agreements to settle trade in local currencies, reducing dependency on the US dollar and mitigating exchange rate risks.
  For example: The India-Russia rupee-ruble trade mechanism reduced pressure on forex reserves during the Russia-Ukraine crisis.
• Enhance External Debt Management: Prioritize low-cost and longer-tenor borrowing while reducing short-term external debt to avoid currency risks.
  For example: India’s increased issuance of sovereign green bonds helped attract stable foreign investments with reduced repayment volatility in 2023.

A robust external sector is pivotal for India’s economic resilience amidst global uncertainties. By fostering export competitiveness, ensuring a prudent fiscal policy, diversifying forex reserves, and enhancing bilateral trade in rupee, India can mitigate currency volatility. A forward-looking strategy emphasizing structural reforms and global economic integration will ensure long-term stability and fortify India’s position in the global economy.

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