Why is The Indian Rupee Falling?

Syllabus: GS3/ Economy

Context

• The Indian rupee has depreciated sharply against the U.S. dollar, with the rupee-dollar exchange rate rising from around ₹85 per dollar in 2025 to beyond ₹96 per dollar in 2026.

What is the Exchange Rate?

• The exchange rate refers to the value of one currency in comparison to another currency. It determines how many units of domestic currency are required to purchase one unit of foreign currency.
  • In India, the rupee-dollar exchange rate indicates the number of rupees required to buy one U.S. dollar.
• Exchange rates are largely determined by the demand and supply of currencies in international markets.

Why is the Indian Rupee Falling?

• Persistent Trade Deficit: India imports more goods than it exports, leading to a persistent merchandise trade deficit.
  • Indian importers exchange rupees for dollars to pay foreign suppliers, increasing demand for dollars. The increased demand for dollars weakens the rupee.
• Rising Crude Oil Prices: India imports a large share of its crude oil requirements from abroad and the rising global crude oil prices significantly increase India’s import bill.
  • Higher oil imports increase dollar demand and exert downward pressure on the rupee.
• Current Account Deficit (CAD): India consistently records a Current Account Deficit because imports exceed exports.
  • Although India earns foreign exchange through software exports and remittances, these inflows are often insufficient to offset the trade deficit fully.
• Foreign Portfolio Investment (FPI) Outflows: FPI includes investments in stocks and bonds by foreign investors.
  • FPI remains highly volatile because investors shift funds quickly based on global financial conditions.
• Rising U.S. Interest Rates: Higher interest rates in the United States attract global investors towards U.S. financial assets.
  • Investors withdraw funds from emerging economies like India and invest in safer U.S. assets.
  • Capital outflows from India increase pressure on the rupee.
• Global Geopolitical Uncertainty: Geopolitical tensions increase uncertainty in global financial markets. Investors prefer safe-haven assets such as the U.S. dollar during periods of instability. This strengthens the dollar globally

How Does a Falling Rupee Affect India’s Economy?

• Inflationary Pressures Rise: Rising import costs increase domestic prices of fuel and essential commodities, eventually leading to increased transportation and logistics costs.
  • This contributes to imported inflation in the economy.
• External Debt Burden Increases: Indian firms with dollar-denominated loans must repay more rupees after depreciation.
  • This increases debt-servicing costs and affects corporate profitability.
• Financial Market Volatility Increases: Large FPI outflows trigger stock market declines and financial market instability weaken investor confidence in the Indian economy.
• Export Competitiveness: A weaker rupee makes Indian goods cheaper in international markets as foreign buyers can purchase Indian products at lower dollar prices. However in the case of India the benefit remains limited due to high import dependence.

Role of the RBI in Stabilising the Rupee

• Forex Market Operations: The RBI intervenes in both the spot and forward markets. When the rupee faces sharp declines due to sudden capital outflows, it sells US dollars to absorb excess demand, and buys dollars during periods of heavy inflows.
• Monetary Measures: The Reserve Bank of India uses interest rate and monetary policy measures to maintain exchange rate stability.
  • Higher interest rates help attract foreign capital inflows and support demand for the rupee.
  • The RBI also controls inflation and maintains investor confidence through monetary policy measures.
• Liquidity Measures: The RBI manages liquidity conditions in the banking system to reduce excessive volatility in financial markets.
  • The RBI injects or absorbs liquidity through instruments such as Cash Reserve Ratio (CRR), Statutory Liquidity Ratio (SLR), and Liquidity Adjustment Facility (LAF).

Way Ahead

• Reducing Oil Dependence: India should expand renewable energy capacity and promote electric mobility.
• Maintaining Adequate Forex Reserves: The RBI should continue maintaining strong foreign exchange reserve buffers to manage external shocks effectively.
• Ensuring Macroeconomic Stability: India should maintain fiscal discipline, moderate inflation, and stable economic growth to strengthen investor confidence.

Source: TH