Depreciation of Rupee

Depreciation of Rupee

Syllabus Areas:

GS III - Economy

The RBI Governor stated that the central bank does not target any specific rupee–dollar level, reaffirming its commitment to a market-determined exchange rate.

• He clarified that the recent depreciation of the rupee is purely market-driven, triggered by factors such as higher demand for the US dollar, trade disruptions, muted capital flows, and the 100% tariff imposed by the United States in October 2025.
• The RBI has intervened only to prevent disorderly volatility and not to hold the currency at any predetermined level.
• He highlighted that India’s foreign exchange reserves of around $690 billion provide adequate strength to manage external shocks.

How does it differs from devaluation?

Exchange Rate Regimes

• India follows a managed floating exchange rate system, where market forces primarily determine the rupee’s value.
• The RBI intervenes only to smooth excessive volatility, a stance repeatedly articulated through MPC communications.
• This system gives flexibility during global shocks while preventing sharp destabilizing movements.

Why the Rupee Depreciates?

• The rupee weakens whenever demand for the US dollar rises relative to supply.
• Key drivers include widening trade deficits, elevated crude oil prices, a stronger global dollar, and heightened global uncertainty.
• The US tariff shock of October 2025 increased export uncertainty, triggered risk-averse behavior among investors, and reduced capital inflows, leading to further rupee pressure.

Role of Forex Reserves

• India’s forex reserves are used for exchange-rate stabilization, import protection (especially crude and food), and crisis management.
• A reserve pool of nearly $690 billion enhances confidence and provides the RBI with sufficient firepower to prevent volatility.

Tariff Shock & Rupee Weakness

Current Situation

• Since August 2025, the rupee has fallen by approximately 3.5–3.6%, touching levels near ₹88.7 per dollar—close to historic lows.
• Traders fear that a breach of the ₹89 per dollar mark may compel stronger RBI intervention.
• The depreciation has been intensified by a stronger US dollar, elevated global crude prices, and a broad weakening across Asian currencies such as the yen, won, and Taiwan dollar.

Trade Elasticity & Exchange Rate Pass-Through

• Tariffs disrupt expected trade flows, causing immediate reactions in currency markets.
• Investors anticipate reduced exports, wider trade deficits, and lower dollar inflows, which together weaken the rupee.
• These expectations translate into faster and deeper exchange-rate adjustments.

RBI Intervention Types

• The RBI intervenes through spot market operations, involving direct purchase or sale of foreign currency.
• It also uses forward contracts and swaps to manage forward-market volatility.
• Liquidity tools support overall financial stability during episodes of currency stress.

RBI’s Stand on Cryptocurrencies

What the Governor Said

• The Governor stressed that the RBI remains “very cautious” about private cryptocurrencies because of their inherent risks.
• He highlighted concerns related to financial stability, money laundering, capital flight, and consumer vulnerability.
• He reiterated that India’s digital payment architecture—UPI and NEFT—is already robust.
• The RBI’s focus is on developing the Central Bank Digital Currency (CBDC), described as a “crypto backed by the central bank,” for domestic and cross-border payments.
• The final policy framework on crypto will be decided by the government and the designated working group.

Background Concepts

Why RBI Opposes Private Crypto

• Private cryptocurrencies lack sovereign backing, making them highly speculative.
• They exhibit extreme price volatility, posing threats to households and investors.
• They undermine monetary policy independence and can enable capital flight.
• They may also weaken India’s capital control regime under FEMA.

CBDC vs Crypto

• CBDCs have central-bank backing, making them stable and recognised as legal tender.
• Private cryptocurrencies lack institutional backing and remain legally unregulated.
• CBDCs promote secure, efficient settlement and enhance financial inclusion.
• India is experimenting with both wholesale and retail CBDC pilots.

Indian Banks and Global Expansion

• The government has not set any specific target for the number of Indian banks that must expand globally.
• With India’s rapid economic growth and increasing bank balance sheets, he said it is only a matter of time before several Indian banks feature among the world’s top 100.

Why Indian Banks Are Growing

• The banking sector is supported by strong credit demand across retail and industrial segments.
• Structural reforms—such as the Insolvency and Bankruptcy Code, the PCA framework, and recapitalisation efforts—have improved asset quality.
• Profitability has risen significantly since FY23 due to better asset quality and credit expansion.
• Digital innovations, including UPI and Aadhaar-based architecture, have strengthened operational efficiency.

Criteria for Global Rankings

• Global bank rankings typically consider asset size, market capitalisation, profitability, and international presence.
• Indian banks like SBI, HDFC Bank, and ICICI Bank are steadily climbing global rankings as their balance sheets expand.

Macro Stability: Growth vs Financial Stability

• The Governor cautioned that short-term growth can be artificially boosted at the cost of financial stability, but instability has severe long-term consequences.
• He emphasised that sustainable growth requires stable financial institutions, credible markets, and disciplined credit expansion.
• The RBI’s core mandate includes maintaining both price stability and financial stability.
• Episodes such as the 2008 financial crisis, the IL&FS collapse, and NBFC stress highlight the dangers of excess credit and inadequate oversight.
• The RBI, therefore, adopts a gradual and calibrated approach to liquidity and credit regulation to prevent bubbles.

Persistent Inflation Pressure

• India continues to experience high price volatility, especially in food prices.
• This volatility remains a major challenge for achieving the inflation target.

Structure of CPI in India

• Food carries a large weight—nearly 46% in rural CPI—making headline inflation highly sensitive to food prices.
• Food inflation is volatile due to monsoon variability, perishable-commodity cycles, government procurement policies, and sudden export/import restrictions.

Monetary Policy Challenge

• Since food inflation is primarily supply-driven, monetary policy has limited direct control over it.
• This makes inflation management more complex and requires coordinated fiscal and supply-side interventions.