The rupee continued its downward trajectory against the dollar, touching a historical low level of 87.94 against the dollar a few days ago. It recovered a bit due to RBI intervention and supply of dollars in the market. A falling rupee may challenge India’s economic growth prospects and undermine the positivity generated by the Budget announcements.
The economy is grappling with a slowdown. It is is expected to grow at 6.4 per cent in 2024-25 as against 8.2 per cent in 2023-24. Tax reduction and other announcements in the Budget are intended to increase consumption, thereby contributing to the rebound of the Indian economy.
To tackle sluggish growth rate, the RBI recently cut the policy rate by 25 basis points. The option of interest rate reduction for stimulating growth may not be feasible in the coming months for three reasons.
First, the RBI managed to cut interest rate without significant pressure on the rupee because of the interest rate cuts by the US Fed during November and December last year. However, the inflation data released recently indicates inflationary tendencies in the US economy. This is likely to reignite due to the recent increase in tariffs.
This implies the US Fed may not cut interest rates further in the near future.
In such situation, if the RBI goes for another rate cut to tackle economic growth, the arbitrage between the US and India interest rate will come down. It may trigger capital flight from India to the US, thereby further increasing the pressure on the rupee.
Second, the rupee depreciation, if not managed, will also affect India’s trade deficit. Theoretically, a depreciating currency is helpful in increasing exports and controlling imports, thereby reducing the trade deficit.
However, the real impact of a depreciating currency on exports and imports depends on the price elasticity of exports and imports. If the sum of the price elasticity of demand for exports and imports is less than 1 (Marshall-Lerner condition), the trade deficit may actually worsen after currency depreciation. Will a depreciating rupee after Trump presidency will benefit or hurt India?
Export-driven industries in India, such as IT and software services, pharmaceuticals, textiles, and auto ancillaries are likely to benefit. Some economists estimated IT companies gaining a 6-8 per cent increase in revenue due to depreciating rupee. The pharmaceutical sector may also see a boost in exports as Indian generic medicine will become more competitive globally.
However, import-dependent sectors such as oil and gas, aviation, consumer durables, students and tourists travelling abroad, and infrastructure would be adversely affected. The aviation sector, for instance, has faced a significant increase in operational costs due to higher fuel prices and lease payments.
Given the inelastic nature of major imported items, imports are unlikely to come down even after depreciation. Exports may take time to adjust to new exchange rates and create new demands. Therefore, the trade deficit may widen in the short run after depreciation. If trade data shows such trends, the RBI may find it difficult to further cut interest rates.
Third, the easing of inflation in January provided some room to the RBI to cut the interest rate to stimulate economic growth. The depreciating currency may result into import of inflation.
Major imports items for India consist of petroleum products, gold, coal, diamond, electronic integrated circuits, automatic data processing machines and palm oil. With inelastic import demand for these products, a rise in the landing price of imports poses an additional risk of inflation.
Silver lining
Nonetheless, a silver lining is that the rupee’s decline has remained relatively modest compared to other global currencies.
During the first nine months of FY25, the rupee recorded a modest depreciation of 2.9 per cent, as compared to the Canadian Dollar (5.4 per cent), South Korean Won (8.2 per cent), and Brazilian Real (17.4 per cent), per the latest Economic Survey.
Though the rupee managed to recover a bit in the last few days due to central bank intervention, it poses a risk of lowering (rupee) liquidity in the economy. This may again affect economic growth as the lending capacity of banks would come down, particularly for the MSME sector.
The RBI and government will have to play a crucial role in stabilising the rupee ensuring balanced growth.
Gupta is Associate Professor at Centre for WTO Studies, IIFT, New Delhi, and Sharma is Assistant Professor at UPES, Dehradun. Views are personal
