Rupee’s Depreciation: Global Volatility & Structural Concerns

Syllabus: GS3/Economy

Context

• Recent rupee’s depreciation against major currencies like the dollar, euro, and yen signals global volatility and deeper structural concerns.

About Rupees Depreciation

• It refers to the decline in the value of the Indian rupee relative to foreign currencies, particularly the US dollar. 
• It means that more rupees are needed to buy a unit of foreign currency, when the rupee depreciates.

Key Drivers of Rupee Depreciation

• Trade Deficit: When imports exceed exports, demand for foreign currency rises, putting downward pressure on the rupee.
• Capital Outflows: Foreign investors pulling money out of Indian markets reduce the supply of foreign currency, weakening the rupee.
• Global Dollar Strength: A strong US dollar, often due to high interest rates in the US, can lead to depreciation of emerging market currencies like the rupee.
• Inflation Differentials: Higher inflation in India compared to its trading partners can erode the rupee’s purchasing power over time.
• Geopolitical and Economic Uncertainty: Global crises or domestic instability can reduce investor confidence, leading to currency depreciation.

Reasons For Current Depreciation

• Nominal Depreciation: The rupee has weakened against most major currencies, including the Chinese yuan (11.66 to 12.63). The NEER’s fall below 85 reflects this broad-based depreciation.
• Lower Domestic Inflation: India’s CPI inflation in October 2025 stood at 0.25%, far below that of major economies like US & Japan (3%); UK (3.6%); Euro Area (2.1%); Indonesia (2.9%); and Brazil (4.7%)
  • The combination of nominal depreciation and low inflation has led to a decline in REER, implying that the rupee is now undervalued and Indian exports may gain price competitiveness.
• Decline in NEER & REER:
  • NEER: Dropped from 90.75 (Jan 2025) to 84.58 (Oct 2025) — a 6.8% decline in just nine months.
  • REER: Fell sharply from its record high of 108.06 (Nov 2024) to 97.47 (Oct 2025) — a 9.8% correction, shifting the rupee from being overvalued to undervalued.

Implications of a Weaker Rupee

• Inflationary Pressures: Imported goods, including electronics, fuel, and essential commodities, are becoming costlier, affecting household budgets.
  • Since India imports over 80% of its oil needs, fuel prices rise, triggering a domino effect on transportation, food, and manufacturing costs, thereby stoking inflation.
• Corporate Profitability: The rupee’s depreciation is expected to erode India’s corporate sector’s (India Inc) profits, particularly for companies with high import dependencies or foreign currency borrowings.
• Trade Balance and Export Competitiveness: While a weaker rupee can boost export competitiveness by making Indian goods cheaper abroad, the benefit is often offset by global demand slowdowns or supply chain disruptions.
  • Moreover, India’s structural trade deficit, driven by high-value imports like oil and electronics, limits the positive impact of currency depreciation.
• Capital Flows and Investor Sentiment: Currency volatility can deter foreign investors, especially in equity and debt markets.
  • Capital outflows driven by global risk aversion and higher US interest rates have exacerbated the rupee’s decline.

IMF’s Reclassification and RBI’s Exchange Rate Policy

• IMF, in its November 26, 2025 report, reclassified India’s exchange rate regime as a ‘crawl-like arrangement’, following its earlier shift from a ‘floating’ to ‘stabilised’ arrangement in November 2023.
  • A crawl-like regime allows gradual adjustments in the currency’s value within a 2% band around a defined trend, providing flexibility while avoiding abrupt movements.
• RBI’s Current Stance: RBI has adopted a more flexible approach, intervening only occasionally to smooth excessive volatility. It is driven by:
  • Easing inflation, reducing the need for a strong rupee.
  • The need to preserve export competitiveness, particularly amid global trade tensions and shifting supply chains.
• RBI has intervened in the forex marketto stabilize the rupee. It may impact:
  • Foreign Exchange Reserves: Continued intervention has led to a drawdown in forex reserves, limiting the RBI’s ability to defend the rupee indefinitely.
  • Inflation Risks: A weaker rupee makes imports more expensive, potentially stoking inflation and complicating the RBI’s monetary policy stance.

What Lies Ahead?

• The rupee’s REER may decline further, keeping it undervalued if the trend of gradual nominal depreciation and subdued inflation continues.
  • Such a position could benefit exporters but may raise import costs over time if global inflation pressures resurface.
• The current undervaluation may offer temporary benefits to trade with India’s inflation under control and external competitiveness improving.
  • However, sustaining stability will require careful balancing between currency flexibility, inflation control, and capital flow management in the months ahead.

Source: IE