A currency can lose ground for several reasons, yet a declining rupee does not inherently spell trouble for the economy. However, at this moment, the usual suspects for such a downturn don’t seem to be at play. Typically, a negative trade balance, where imports significantly exceed exports, could be detrimental. Nevertheless, this isn’t the current situation. The current account deficit, which is net trade balance and services, stands at a manageable 1.2% of GDP.
The rupee can also come under pressure, if there’s a large forex outflow. But foreign direct investment (FDI) inflows have been positive. In fiscal year 2024 (FY24), foreign portfolio investors (FPIs) invested ₹3.2 trillion, with net ₹2.04 trillion invested in equity, and net ₹1.19 trillion in rupee-debt.
Another possible reason for currency woes is a fear of rising inflation. But inflation is normalising and expected to decline. GDP growth has also accelerated in FY24. The Reserve Bank of India (RBI) has record reserves of $642 billion as well, so there’s zero fear on the external front.
So what is the reason, or reasons, for currency pressure? One reason is political uncertainty. No matter how popular the incumbent regime may be, there’s always uncertainty prior to a general election. Currencies do become volatile in the run-up to elections.
There are other reasons. One is that the US dollar has strengthened against every currency as America’s growth has accelerated and inflation declined. The Federal Reserve has also signalled that it will cut policy rates in 2024, which has pushed up the dollar in anticipation of the actual cuts.
As other Asian currencies such as the yuan, taka, won, dong, and yen have declined against the US greenback, the RBI, too, has allowed the rupee to weaken. The central bank buys or sells forex to keep the rupee’s value at what it considers the “sweet spot”. If the rupee is getting too “strong”, the RBI buys dollar (or other currencies) selling rupees and that pulls the value down.
If the rupee is getting too “weak” for comfort, the RBI sells forex. There was a long period between September 2021 and November 2022 when the RBI sold over $110 billion worth of forex to sustain the rupee’s value. But it has only intervened in a minor way in the past six months.
There are benefits to having a weaker currency. It enhances the competitiveness of exports, a strategy China has employed for many years and Japan used in the 1980s. Additionally, a depreciating currency increases the cost of imports, which can lead to a reduction in trade deficits or even the creation of surpluses due to increased exports and decreased imports.
The RBI might have allowed the rupee to depreciate to support export competitiveness. But mercantilism as it’s called, can fuel inflation, especially in energy-deficit India, since we pay for oil and gas in dollar. So, the RBI did intervene at below ₹83.5.
Incidentally, despite all the hype about governments wanting a stronger or weaker rupee, there’s compelling data indicating successive governments have allowed the RBI to manage the rupee without much interference.
In 2004, when the United Progressive Alliance (UPA) government took charge, the rupee was at around ₹44.6 to a dollar. When Narendra Modi took over in 2014, the rupee was at ₹60. During the ten UPA years, the rupee weakened at 3.3% compounded. Ten years after Modi took charge, it is down to ₹83.40 (with a dip to ₹83.73) – it has weakened at 3.3% compounded. The long trend hasn’t changed through the last 20 years, despite two different governments, two global financial crises, the pandemic, demonetisation, etc., and four different RBI governors in charge.
Incidentally, the rupee has lost much less ground against the euro (down 0.9 % compounded), the pound (down 0.6 % compounded) or the yen (up by 0.5 %) during the last ten years. Over 65% of India’s trade is dollar-denominated, so there’s the focus.
That long-term trend does suggest we can expect the rupee to continue to slide lower at something like 3% or 3.5% a year compounded. Obviously this is not a smooth trend – there are periods of sharp falls and sharp recoveries. But that seems to be the long-term target of RBI policy and it seems successive government have been content to let the central bank do what it thinks is best.
