The Indian rupee has been making headlines recently, and not for the right reasons. The currency has been on a downward spiral, breaching the crucial 80-mark against the US dollar and continuing to set new record lows. Over the past year, the rupee has fallen by more than 5%, sparking widespread concern and debate. But is the rupee’s decline as alarming as it seems? Let’s break it down.

The Basics of Currency Valuation

To understand the rupee’s fall, we need to start with the basics. The value of a currency is always relative, and since the US dollar is the world’s primary reserve currency, most currencies, including the rupee, are measured against it. This is because the US is the largest global economy, and international trade, including India’s oil imports, is conducted in dollars. For example, when India buys oil from Saudi Arabia, it pays in dollars, not rupees. This makes the dollar the benchmark against which other currencies are compared.

The exchange rate between the rupee and the dollar is determined by supply and demand. If the demand for rupees is higher than the demand for dollars, the rupee strengthens. Conversely, if the demand for dollars outstrips that for rupees, the rupee weakens. Currently, the exchange rate stands at around ₹87 to $1, meaning you need ₹87 to buy one dollar.

Why Is the Rupee Weakening?

The rupee’s decline has been steady over the past year. Between 2021 and 2022, the rupee fell from 72 to 82 against the dollar—a 10% drop. By October 2022, it had crossed 83, prompting Finance Minister Nirmala Sitharaman to comment, “I would look at it as the dollar strengthening, not the rupee sliding.” This statement sparked controversy, with opposition leaders like Rahul Gandhi criticizing the government’s handling of the economy.

However, Sitharaman’s point holds weight. The rupee isn’t weakening in isolation; the dollar is strengthening globally. In fact, other currencies like the Chinese yuan have also weakened against the dollar. Between October and December 2024, the rupee fell by 1.6%, while the yuan fell by 4.1%. This suggests that the rupee’s decline is part of a broader trend of dollar strength, not just an Indian problem.

Why Is the Dollar Strengthening?

The dollar’s strength can be attributed to two main factors: the robust performance of the US economy and the policies of former President Donald Trump.

1. US Economic Growth: From 2020 to 2023, the US faced high inflation, prompting the Federal Reserve (the US central bank) to raise interest rates. Higher interest rates reduce borrowing and spending, slowing down the economy and curbing inflation. While this helped control inflation, it also attracted international investors. With higher returns on investments in the US, investors moved their money out of other countries, including India, and into the US. This increased demand for the dollar, strengthening it further.
2. Trump’s Tariff Policies: Donald Trump’s presidency brought significant changes to US trade policies. His administration imposed tariffs on imports, making foreign goods more expensive and boosting demand for American products. While Trump aimed to weaken the dollar to make US exports cheaper, his policies had the opposite effect. The tariffs increased the dollar’s value, further pressuring currencies like the rupee.

India’s Trade Deficit: A Contributing Factor

While the dollar’s strength is a major factor, India’s own economic dynamics also play a role. India is a net importer, meaning it imports more than it exports. Key imports like oil and gold require dollars, increasing demand for the currency. Despite exports in sectors like IT and pharmaceuticals, India’s trade deficit persists, putting additional pressure on the rupee.

For instance, gold imports have quadrupled in recent years, partly due to reduced customs duties. This has further increased the demand for dollars, weakening the rupee. However, a weaker rupee isn’t all bad news. For IT and pharmaceutical companies that earn in dollars, a strong dollar means higher revenues in rupee terms. But whether this trickles down to employees depends on company policies.

RBI’s Role in Managing the Rupee

The Reserve Bank of India (RBI) has been actively intervening to stabilize the rupee. Since October 2021, the RBI has spent an estimated $100-150 billion to manage the exchange rate. This is a significant amount, comparable to India’s annual oil import bill. Critics, including former Chief Economic Advisor Arvind Subramaniam, argue that such interventions are wasteful and unnecessary.

India’s exchange rate system is supposed to be a free-float, where market forces determine the currency’s value. However, the RBI’s recent actions resemble a pegged system, where the central bank actively manages the exchange rate. Subramaniam and other economists believe the rupee is overvalued and should be allowed to weaken further to reflect market realities.

The Politics of the Exchange Rate

The rupee’s decline has become a political issue, with celebrities and spiritual leaders weighing in. However, economic decisions should be based on data, not rhetoric. The RBI’s interventions may have been driven by political considerations, such as protecting companies with foreign loans or controlling inflation. But these measures come at a cost, and many economists argue that the RBI should focus on inflation and growth, leaving the exchange rate to market forces.

Key Takeaways

1. Context Matters: The rupee’s decline is part of a global trend of dollar strength, not just an Indian problem.
2. Dollar Dominance: The US economy’s performance and policies significantly impact global currencies.
3. India’s Trade Deficit: As a net importer, India’s demand for dollars will continue to pressure the rupee.
4. RBI’s Role: While the RBI’s interventions aim to stabilize the rupee, they may not be sustainable in the long term.
5. Economic Literacy: It’s crucial to base economic views on data, not sensational headlines or celebrity opinions.

In conclusion, the rupee’s decline is a complex issue influenced by global and domestic factors. While it’s easy to panic, understanding the underlying dynamics can provide a clearer perspective. As Finance Minister Sitharaman pointed out, sometimes the story isn’t about the rupee sliding but the dollar strengthening. And in economics, context is everything.