The rupee seems to be falling freely against the dollar, fuelled by a strong dollar, high US interest rates and reduced net capital inflows. Donald Trump’s policies of tariff hikes and tighter immigration are seen as inflationary, and the US-Fed is unlikely to lower interest rates anytime soon. On November 6, the day of the US election results, the rupee was trading at 84.09 to a dollar.
On February 14, it slumped to 86.58, after recovering from its life-low mark of 88 in the previous week. Despite RBI’s selling of dollars to stabilise the rupee, it lost 2.96 per cent of its value during this period. Over this period, Chinese Yuan lost 2.67 per cent of its value.
The Dollar Index (DXY), which tracks the strength of the dollar against a basket of major currencies, rose from 105.09 to 109.64 on January 13 before falling to 106.57 on February 14. It seems that the rupee is depreciating not because of its own weakness, but rather because the dollar is strengthening, especially after the victory of Trump who is bent upon maintaining its dominance at any cost.
The US economy grew robustly in 2024, at nearly 2.5 per cent, outpacing the 1.7 per cent growth forecast for developed economies. This, combined with rising US Treasury yields and better-than-expected job growth in the US market, are leading to increased demand for US assets and a stronger dollar, as investors find US bonds more attractive. The only challenge to the dollar’s continued rise is the structural challenge posed by persistent US trade deficits which reached 4.2 per cent of GDP in September 2024, and Trump is determined to reduce it through tariffs.
Relative inflation is also a major determinant of the rupee’s fall — as prices rise faster in India compared to the US, the rupee naturally depreciates for maintaining purchasing power to equalise the price of a basket of goods across countries.
Strengthening dollar
The dollar has been strengthening even before Trump’s win; in 2024, the DXY rose by 7.1 per cent year-on-year, while the rupee, the yuan and the euro fell respectively by 2.8 per cent, 2.8 per cent and 6.2 per cent.
To arrest the fall of the rupee, the RBI has already sold substantial amount of our forex reserves which has now dwindled from over $700 billion in early October to only $638 billion on February 7. It has led to increased capital outflows and “dollar hoarding” in anticipation of further rupee depreciation.
Value of a currency vis-à-vis another depends primarily on demand-supply equilibrium. Factors that influence the inflows and outflows of dollar are mainly GDP growth, level of fiscal deficit, current account deficit (CAD) and inflation relative to the US.
Besides signals of slowdown in the Indian economy and dwindling corporate earnings, the fall of the rupee was precipitated by withdrawals by foreign institutional investors (FIIs).
It was triggered by the liberal Chinese stimulus in September 2024 to boost domestic consumption and revive China’s sagging property sector, followed by Trump-induced outflows to US bonds, when Indian stock market nosedived. .FIIs have taken out huge sums from Indian markets, which explains the slide of the Sensex from 86,000 in early September to less than 76,000 now, and the volatility might continue until there is clarity on tariffs and improvement in corporate earnings.
It is not the first time that the rupee has experienced a sharp fall against the dollar. In 1993, when India adopted a market-determined exchange rate regime.
The rupee has been falling ever since, from 26 to a dollar in 1993, to above 60 in 2014 and 85 last December. Differential between growth rates in the Indian and US economies favours the rupee to appreciate while the inflation differential causes it to depreciate.
The former has delivered around 1-1.5 per cent appreciation per annum, while the latter has led to depreciation by around 5 per cent, with the result that the rupee has been depreciating by 3.5-4.5 per cent per annum over the last three decades, and may breach the level of 100 to a dollar well before 2030.
A weaker rupee increases competitiveness of exports while making imports costlier and stoking inflation.. We must brace for difficult times ahead.
The writer is a former Director General at the CAG of India, and is currently a Professor at Arun Jaitley National Institute of Financial Management. Views are personal
