The Reserve Bank of India has relaxed its control over the rupee, allowing it to depreciate against the US dollar due to rising crude oil prices, import costs, and the strengthening US dollar. This has led to a net outflow of foreign capital, with many FIIs shifting to China.
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Picture Courtesy: Indian Express
The Reserve Bank of India (RBI) has relaxed its control over the rupee, allowing it to fall to a record low of 86.70 on January 13, 2025.
The recent decline in the rupee value is mainly due to an increase in crude oil prices (West Asia crisis), which has raised India's import costs; increasing the demand for dollars.
Foreign Institutional Investors (FIIs) recently sold their Indian shares of a value of Rs 4,329.79 crore, which resulted in a net outflow of foreign capital from India. Many foreign institutional investors (FIIs) are shifting their investments to China, where the government has announced attractive financial incentives.
Domestic structural economic weaknesses include a large current account deficit, which is mainly caused by high dependence on imports of energy and critical materials. Despite efforts such as the 'Make in India' initiative, dependence on imports in sectors such as electronics, machinery, and chemicals has not decreased, bringing pressure on the rupee
The weakening of the rupee has been partly due to the strengthening US dollar and the overvaluation of the real effective exchange rate (REER), which measures a currency’s value against a basket of other currencies, adjusted for inflation.
RBI has shifted its control over the rupee and allowed it to depreciate against the US dollar. It is a shift from RBI's earlier approach of tightly managing the rupee to prevent sharp declines.
Since November 2024, the rupee has depreciated by 2.6%, and on January 13, 2025, it hit a historic low of 86.70 per US dollar, registering its steepest single-day fall in nearly two years.
Experts suggest that the RBI's declined intervention reflects a growing tolerance for rupee depreciation. It is also a resource-efficient strategy because it reduces the need for extensive interventions.
Analysts are cautious about relating this change to the new RBI Governor, Sanjay Malhotra, who took charge in December 2024. They argue that the RBI, as an institution, was already aligned with the previous approach under former Governor Shaktikanta Das, and significant strategy changes take time.
Since September 2024, the foreign exchange reserves have dropped by $79 billion reaching $625.87 billion in January 2025. This fall is largely due to the RBI's dollar sales to manage the rupee's value, as well as a net outflow of over Rs 1,43,000 crore by foreign investors since October 2024.
The depreciation of the rupee can have both positive and negative effects on the Indian economy.
Positive effects
Negative effects
The depreciation of the rupee could increase imported inflation, especially for oil products. Since the rupee's decline increases the cost of imports, it is expected to contribute to higher inflationary pressures, which are already projected at 4.5% for Q4 of FY24.
The rising costs of oil will likely exacerbate inflation, affecting both consumers and businesses.
The future of the Indian rupee is influenced by many factors, including the strength of the US dollar, inflation, economic growth, and geopolitical tensions.
Experts predict that the rupee could depreciate more and can reach around 87 per dollar by March 2025, however, it will depend largely on global economic conditions and the impact of Trump’s policies.
The Reserve Bank of India (RBI) has shifted its approach of intervention in currency markets to balance market stability with resource conservation. However, the long-term impact remains uncertain and depends on both global and domestic factors.
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