Recently, The Indian rupee’s exchange rate against the US dollar has breached the 85 mark.

About Exchange Rate 

• The exchange rate represents the value of one currency relative to another. 
  • For example, ₹85 per $1 means that 85 Indian rupees are required to purchase one US dollar.
• Exchange rates fluctuate based on the demand and supply of currencies in the foreign exchange market. 
  • A higher demand for US dollars compared to Indian rupees results in the depreciation of the rupee.
• Depreciation of Domestic Currency: An increase in exchange rate implies that the price of foreign currency (dollar) in terms of domestic currency (rupees) has increased. 

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Factors Influencing Exchange Rate

• Trade Deficit: A persistent trade deficit occurs when imports exceed exports, increasing the demand for US dollars to pay for imports. This leads to the depreciation of the Indian rupee.
  • For example, in October 2024, India’s trade deficit widened to $27.14 billion, putting pressure on the rupee.
• Inflation: High domestic inflation reduces the purchasing power of the rupee, making Indian goods less competitive in global markets and weakening the currency.
  • In October 2024, India’s retail inflation stood at 6.21%, exceeding the Reserve Bank of India’s target range of 2-6%.
• Capital Outflows: Foreign portfolio investors withdrawing investments from Indian markets lead to a reduction in the demand for rupees, causing its depreciation.
  • In October 2024, foreign portfolio investors had pulled out Rs 94,017 crore from Indian markets.
• Stronger US Dollar: The US dollar index, which measures the dollar’s strength against a basket of currencies, rose by over 7%  since October 2024. This strengthening of the US dollar further weakened the Indian rupee.
• Global Factors: Rising crude oil prices increase India’s import bill, thereby requiring more US dollars and weakening the rupee.
  • As of June 2024, India’s external debt was $682.3 billion, also becoming more expensive to service as the rupee depreciates.
• Trade Restrictions: US trade policies, such as imposing tariffs on Indian goods, reduce the demand for Indian rupees in international markets, leading to a weaker currency.

Impacts of a Depreciating  Rupee

Positive Impacts

• Boosts Export Competitiveness: A weaker rupee makes Indian goods and services cheaper in the international market, increasing their demand.
  • Export-oriented industries such as IT, textiles, and pharmaceuticals benefit significantly.
• Encourages Remittances: A depreciating rupee makes remittances sent by Indians working abroad more valuable in rupee terms, benefiting their families and contributing to the economy.
• Improves Domestic Production for Substitution: Imported goods become more expensive, potentially encouraging domestic production to replace imports. This supports the “Make in India” initiative.
• Boosts Tourism in India: A weaker rupee makes India a cheaper destination for foreign tourists, potentially increasing revenue from tourism.

Negative Impacts

• Costlier Imports: The cost of essential imports, especially crude oil, increases. India imports 80% of its crude oil needs, and higher oil prices lead to inflation and pressure on household budgets.
  • Other imports like electronics and machinery also become expensive, affecting industries and consumers.
• Widening Deficits: Costlier imports contribute to a higher trade deficit and current account deficit, which further weakens the rupee and strains the economy.
• Rising Inflation: A weaker rupee leads to imported inflation, as higher costs of goods like crude oil and machinery ripple through the economy.
• Higher Debt Servicing Costs: India’s external debt, amounting to $620 billion (as of June 2024), becomes more expensive to service as the rupee depreciates.
• Impact on Outbound Travel and Education: Traveling abroad becomes costlier for Indians. 
  • Tuition fees and living expenses for Indian students studying abroad also increase, adding financial stress.
• Reduces Investment Confidence: A depreciating rupee can deter foreign investments as it signals macroeconomic instability. Investors may pull out funds, further weakening the currency.

Way forward

• Boost Exports: The government should enhance export competitiveness through initiatives such as the Production Linked Incentive (PLI) schemes.
• Attract Foreign Investment: Efforts to improve the ease of doing business can attract more foreign direct investment (FDI).
• Control Inflation: The Reserve Bank of India has raised interest rates to combat inflation, though further measures may be required to stabilize prices.
• Currency Diversification: India should explore agreements for rupee trade with other countries to reduce reliance on the US dollar.

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Conclusion

The depreciation of the Indian rupee presents both challenges, such as higher import costs and inflation, and opportunities, like increased export competitiveness. Effective policy measures are essential to mitigate negative impacts while leveraging potential benefits for economic growth.