The persistent depreciation of the Indian rupee has significant implications for India’s external sector and domestic economy. Discuss the key factors contributing to the rupee’s depreciation and suggest measures to enhance external resilience in the face of such challenges.
The persistent depreciation of the Indian rupee has been a critical challenge for the Indian economy, impacting its external sector and domestic stability. The rupee’s decline reflects the interplay of global economic shifts, geopolitical tensions, and domestic structural issues. Addressing this issue requires an understanding of the key factors contributing to rupee depreciation and the implementation of strategic measures to enhance external resilience.
Key Factors Contributing to Rupee Depreciation:
Sustained Outflows of Foreign Portfolio Investments (FPIs)– One of the primary reasons for the rupee’s depreciation is the sustained outflow of FPIs. For instance, between April and December 2023, FPIs withdrew over $10 billion from Indian equity markets due to concerns over overstretched valuations and weak corporate earnings during the July-September quarter. Adding to this, China’s aggressive economic stimulus in 2023 attracted significant capital flows, diverting investments from Indian markets.
Strengthening of the US Dollar– The strengthening of the U.S. dollar further compounded the rupee’s woes. The Dollar Index rose from 103 in early 2023 to 110 by the year’s end, driven by geopolitical uncertainties and protectionist policies under the Trump administration. Speculation about tariffs on BRICS nations’ efforts to challenge dollar dominance intensified investor demand for the greenback (the desire or need to acquire US dollars), further pressuring the rupee.
Widening Trade Deficit and Current Account Deficit (CAD)– India’s widening trade deficit and current account deficit (CAD) also contributed significantly. The trade deficit surged to a record $275 billion in FY 2023–24, with crude oil imports accounting for a substantial portion. India’s dependence on imported edible oils, which saw international prices rise by 20% in 2023, exacerbated this burden. Consequently, CAD is projected to double from 1.2% to nearly 2.5% of GDP in FY 2024–25.
High Import Dependency– India’s high reliance on imported crude oil has exposed the economy to global energy price fluctuations. For example, the Russia-Ukraine conflict caused crude oil prices to surge to $110 per barrel in mid-2023, contributing to inflationary pressures and worsening the import bill.
Global Monetary Tightening– Global monetary tightening added another layer of pressure. The U.S. Federal Reserve’s interest rate hikes to 5.5% in 2023 attracted capital outflows from emerging markets, including India.
Domestic Economic Weaknesses– Domestically, faltering consumption demand and sluggish private investments further weakened economic resilience. For example, the GDP growth rate slowed to 5.9% in Q3 FY 2023–24, with the MSME sector facing a 15% decline in production due to high input costs and subdued demand.
Geopolitical Tensions and Policy Shifts– Geopolitical uncertainties, such as those surrounding the H-1B visa regime, created apprehensions for India’s IT sector. Additionally, lack of clarity on India’s stance on de-dollarisation added to investor caution.
Limited Forex Reserve Utilization– The RBI’s ability to stabilize the rupee was constrained by falling forex reserves, which declined from $600 billion in 2022 to $570 billion by December 2023.
External Shocks- The ongoing Russia-Ukraine war and rising global geopolitical tensions have intensified currency volatility across emerging markets, including India.
Measures to Enhance External Resilience
Diversification of Export Base– India must expand its export base by exploring non-traditional markets and promoting high-value goods like pharmaceuticals and IT services. For example, exports to Africa grew by 15% in FY 2023–24, driven by pharmaceuticals and machinery.
Reducing Import Dependency– Encouraging domestic production through incentives and investments is essential. For instance, the Production Linked Incentive (PLI) scheme for renewable energy aims to cut crude oil imports by 10% by 2030.
Strengthening Foreign Exchange Reserves– Policies to attract stable foreign direct investment (FDI) can bolster forex reserves. In FY 2023–24, India attracted $70 billion in FDI, particularly in infrastructure and technology sectors.
Managing Fiscal and Current Account Deficits– India must reduce non-essential imports and improve its balance of payments. Efforts such as integrating the Unified Payments Interface (UPI) with global systems have boosted remittance inflows, which grew by 20% in FY 2023–24.
Monetary and Exchange Rate Policies– The RBI’s flexible intervention strategies, such as stabilizing the rupee at ₹85 in 2023, highlight the need for active currency management.
Promoting Ease of Doing Business– India improved to 59th in the World Bank’s Ease of Doing Business rankings in 2023, facilitating increased FDI and addressing regulatory bottlenecks.
Trade Policy Reforms– Free trade agreements like the Comprehensive Economic Partnership Agreement (CEPA) with the UAE boosted bilateral trade by 27%. Strengthening regional ties with ASEAN, which accounted for $110 billion in trade in FY 2023–24, is equally vital.
Boosting Domestic Growth– Targeted fiscal measures, such as infrastructure investments under the PM Gati Shakti plan, which amounted to ₹1.3 lakh crore in FY 2023–24, have improved productivity.
Geopolitical and Diplomatic Efforts– Maintaining strategic clarity in currency policies and proactively engaging in platforms like the G20 has reassured global markets about India’s economic stance.
Conclusion
The rupee’s persistent depreciation underscores the need for a robust and comprehensive policy framework to strengthen India’s external resilience. By addressing structural vulnerabilities, diversifying exports, and implementing strategic reforms in trade and investment, India can mitigate external shocks and ensure long-term currency stability. Effective management of the rupee’s trajectory will not only bolster economic growth but also enhance India’s global economic standing.