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Rupee vs Dollar and Impacts
Context:
The Indian rupee plunged to an all-time low of 87.29 per US dollar on Monday February 3, driven by a sharp surge in the dollar index, which gained over 1.24%, reaching 109.84.
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- The sharp depreciation was triggered by US President Donald Trump’s imposition of tariffs on Canada, Mexico, and China, sparking fears of a global trade war.
- On Friday, the rupee had closed at 86.62 per dollar, but escalating trade tensions and strong US economic indicators pushed the dollar higher, leading to a further depreciation of the Indian currency.
Why Did the Rupee Weaken?
- The primary catalyst behind the rupee’s fall was the US imposing steep tariffs:
- 25% tariffs on imports from Mexico and Canada
- 10% tariffs on imports from China
- 10% tariffs on energy imports from Canada
- In response, Canada retaliated with 25% tariffs on US imports, while Mexico is expected to announce similar measures.
- China has also indicated it may take the matter to the World Trade Organisation (WTO).
- These developments have intensified global market uncertainties, making the US dollar a preferred safe-haven asset.
- Additionally, financial services firm Angel One reported that the rupee’s depreciation is largely due to the strengthening of the US dollar, which has been fueled by:
- Robust US job data
- Rising US Treasury yields
- Higher interest rate expectations
- The US-German 10-year yield spread has widened to a five-year high of 2.15%, further attracting investors toward the dollar, while risk-averse sentiment continues to pressure emerging market currencies.
Foreign Institutional Investor (FII) Outflows Add Pressure
- Foreign institutional investors (FIIs) have been net sellers in Q3 of FY25, withdrawing approximately $11 billion from Indian markets.
- This capital outflow, combined with a widening trade deficit (which has reached $188 billion year-to-date in FY25 and is expected to grow 18% over FY24), has weakened the rupee further.
- The Reserve Bank of India (RBI) has intervened by selling an average of $3.3 billion in forex reserves over the past seven weeks.
- However, its intervention remains measured, allowing for a gradual adjustment of the currency.
Impact of a Falling Rupee
The depreciation of the rupee has both positive and negative consequences for the Indian economy:
Negative Impacts
- Costlier Imports & Inflation: A weaker rupee increases the cost of crude oil and other imports, leading to higher production costs and inflation.
- Higher Costs for Companies with Foreign Debt: Indian corporations with dollar-denominated debt face higher repayment costs, straining balance sheets and limiting new investments.
- Lower Consumer Purchasing Power & Economic Slowdown: Higher import costs can reduce domestic spending, impacting overall economic growth.
- Potential capital flight and lower foreign direct investment (FDI) inflows could also hurt the economy.
Positive Impacts
- Boost for Export-Oriented Sectors: A weaker rupee makes Indian exports more competitive, benefiting sectors like IT, pharmaceuticals, and textiles.
- Stock markets have already rallied in IT and pharma stocks in anticipation of higher export earnings.
- Higher Remittances: For Indians living abroad, a weaker rupee means higher remittance value, which supports economic growth, particularly in states dependent on foreign remittances.
RBI’s Dilemma: Balancing Growth, Inflation & Currency Stability
- The RBI faces a tough choice—whether to allow a free-market adjustment of the rupee or intervene aggressively to stabilise it.
- Analysts suggest that while the RBI favors a gradual depreciation, it cannot afford an uncontrolled slide.
- If the rupee reaches 88 per dollar, it would mark a 6.3% depreciation, which is significant but not unprecedented.
- Meanwhile, speculation is high that the RBI may announce a rate cut in February, depending on how it prioritises inflation control, growth, and currency stability.
- The RBI’s monetary policy committee (MPC) is set to meet later this week, where discussions on the rupee’s movement and policy response will be a key focus.
With global trade tensions rising and investor sentiment favoring safe-haven assets, the rupee could remain under pressure in the near term. The RBI’s response, along with government measures to stabilise investor confidence, will be critical in determining the currency’s trajectory.
