Why the Indian Rupee Is Falling Against the Dollar: Key Causes, Impacts, and Insights

Why in News?

The Indian rupee has weakened against the US dollar, breaching the ₹85 mark. This means ₹85 is now required to purchase $1.
In April, the exchange rate hovered around ₹83, whereas a decade ago, it was about ₹61, indicating a consistent decline in the rupee’s value relative to the dollar.

What Is the Exchange Rate?

While the Indian rupee is used for domestic transactions, international purchases, such as buying an American car or traveling to Switzerland, require converting rupees into foreign currencies like the US dollar or euro.
The exchange rate defines how many rupees are needed to buy one unit of foreign currency.
In the currency market, where currencies are traded like commodities, exchange rates are influenced by fluctuations in demand and supply.

Factors Affecting Exchange Rates

Exchange rates are influenced by the supply-demand dynamics of currencies.
When Indians demand more US dollars than Americans demand Indian rupees, the dollar strengthens while the rupee weakens, making dollars more expensive.

Key Factors:

Trade in Goods: A trade imbalance, where India imports more goods from the US than it exports, increases the demand for US dollars, weakening the rupee.
Trade in Services: If Indians consume more US services (e.g., tourism) than Americans use Indian services, the demand for the dollar rises, further weakening the rupee.
Investments: If Americans invest more in India, the rupee’s value may appreciate. Conversely, if Indians invest less in the US, the dollar strengthens against the rupee.

External Influences on Demand

Several factors drive the demand for rupees or dollars:

Trade Restrictions: Tariffs or bans on Indian exports reduce demand for rupees, weakening the currency.
Inflation Differences: Higher inflation in India relative to the US erodes the rupee’s value, discouraging investments and weakening the currency further.

Why Is the Rupee Falling Now?

Recently, the rupee reached ₹85.11 per US dollar, primarily due to a strengthening dollar rather than a significantly weakening rupee.
While the rupee has depreciated against the dollar since September, it has strengthened against other major currencies like the euro, pound, and yen.

Global Factors Strengthening the Dollar:

US policy measures, including possible tariffs, deportations, and tax cuts, have heightened inflation concerns, prompting the US Federal Reserve to maintain tight monetary policies.
Higher US bond yields have made the dollar more attractive, leading to its appreciation.

Impacts of the Falling Rupee

Negative Effects:

Higher Inflation: India imports nearly 80% of its crude oil. A weaker rupee raises import costs, escalating inflation and input prices across various sectors.
Widening Current Account Deficit: As a significant portion of India’s imports is dollar-denominated, costlier imports widen the trade and current account deficits, further pressuring the exchange rate.

Positive Effects:

Boost to Remittances: A weaker rupee makes remittances from overseas workers more valuable in India.
Export Competitiveness: Depreciation benefits exporters unless they rely on imported raw materials, which become more expensive.

Policy Recommendations for India

To address the rupee’s depreciation:

Monitor the rupee’s effective exchange rate against a broader basket of currencies instead of focusing solely on the dollar.
Avoid using interest rates to stabilize the rupee; prioritize domestic inflation trends when setting rates.
Ensure macroeconomic stability by addressing fiscal and current account deficits, adhering to inflation targets, and fostering confidence in India’s growth prospects.

1. What does it mean when the Indian rupee depreciates against the US dollar?

When the rupee depreciates, it means that more rupees are required to buy one US dollar. For example, if the exchange rate goes from ₹83 to ₹85 per dollar, it signifies a weaker rupee.

2. Why is the Indian rupee weakening against the US dollar?

The rupee’s weakening is due to factors like high demand for US dollars for imports, trade imbalances, inflation differences, and global market dynamics that strengthen the dollar.

3. What is an exchange rate?

An exchange rate determines how much one currency (e.g., the rupee) is worth compared to another currency (e.g., the dollar). It fluctuates based on demand and supply dynamics in the currency market.

4. How do trade imbalances impact the rupee’s value?

If India imports more goods or services from the US than it exports, the demand for dollars increases compared to rupees, weakening the rupee.

5. What is the role of inflation in currency depreciation?

Higher inflation in India compared to the US reduces the purchasing power of the rupee, discourages investment, and decreases its demand, leading to depreciation.

6. How do investments influence the exchange rate?

Foreign investments in India increase demand for the rupee, strengthening it. Conversely, reduced foreign investments or higher Indian investments abroad can weaken the rupee.

7. Has the rupee weakened only against the US dollar?

While the rupee has depreciated against the dollar recently, it has appreciated against other currencies like the euro, pound, and yen during the same period.

8. What global factors have contributed to the dollar’s strength?

US policies, tighter monetary strategies by the Federal Reserve, and higher bond yields have made the dollar more attractive, strengthening its value globally.

9. What are the negative impacts of a weaker rupee?

Higher import costs, especially for crude oil.
Increased inflation as higher import costs raise overall prices.
A widening trade and current account deficit due to costlier imports.

10. Are there any positive impacts of a depreciating rupee?

Increased remittance value for families receiving money from abroad.
Enhanced competitiveness of Indian exports, provided raw material costs are not significantly affected.

11. How does a weak rupee affect inflation in India?

India imports nearly 80% of its crude oil, and a weaker rupee makes these imports more expensive, escalating transportation and production costs, leading to higher inflation.

12. What measures can India take to address the rupee’s depreciation?

Focus on the rupee’s performance against a basket of currencies, not just the dollar.
Adjust interest rates based on domestic inflation, not merely to defend the rupee.
Ensure macroeconomic stability by reducing fiscal and current account deficits and adhering to inflation targets.

13. Can the government or central bank directly control the exchange rate?

While the Reserve Bank of India can intervene in currency markets to stabilize the rupee, exchange rates are primarily determined by market demand and supply dynamics.

14. Does a weaker rupee benefit exporters?

Yes, a weaker rupee can make Indian goods cheaper for foreign buyers, boosting exports. However, this benefit can be offset if exporters rely heavily on imported raw materials.

15. What should businesses and consumers do in response to a falling rupee?

Businesses may need to optimize supply chains and hedge against currency risks.
Consumers should anticipate potential price increases for imported goods and services.

16. Why should India focus on macroeconomic stability?

Macro stability reduces reliance on foreign borrowing, maintains investor confidence, and supports a resilient currency amidst global market fluctuations.