Performance of the Indian Rupee against the US Dollar in the last 10 years

#### GS Paper 3

Syllabus: Indian Economy

Source: IE

Context: The rupee’s exchange rate has weakened against the US dollar in the last 10 years. But its “real” strength against a basket of global currencies has improved.

Before we analyse, 1st revise a few basic definitions:

Term | Definition

Exchange Rate | The rate at which one currency can be exchanged for another currency. It represents the value of one currency in terms of another currency. They are of three types:

Fixed Exchange Rate: Governments or central banks set the value of their currency in relation to other currencies and maintain that value by buying or selling their own currency.

Floating Exchange Rate: The value of a currency is determined by the forex market based on supply and demand. Most major currencies operate under this system.

Managed Float: A mix of fixed and floating exchange rates where governments intervene occasionally to stabilize their currency’s value.

Effective Exchange Rate | The weighted average of a currency’s exchange rates against other currencies, is adjusted for inflation and trade competitiveness.

Currency weights are derived from the share of individual countries in total foreign trade.

Nominal Effective Exchange Rate (NEER) | A simple average of bilateral exchange rates between the domestic currency and the currencies of major trading partners, weighted by respective trade shares.

NEER measures the overall strength or weakness of a currency relative to a basket of other currencies without adjusting for inflation.

Real Effective Exchange Rate (REER) | Adjusts NEER for differences in inflation rates between the domestic economy and its trading partners. Reflects changes in the relative price levels of goods and services.

Provides a more accurate measure of a currency’s trade competitiveness by accounting for changes in price levels.

Status of the Indian Rupee in the last 10 years:

• The rupee fell from Rs 44.37 to Rs 60.34 (26.5%) from 2004 to 2014 against the US dollar

• From 2014 to 2024, the rupee further depreciated from Rs 60.34 to Rs 83.38 (27.6%) against the US dollar.

• Between 2004 and 2024, the rupee declined by 32.2% (from 133.77 to 90.76) as per the 40-currency basket NEER

• Despite this, between 2004 and 2024, the rupee has undergone a smaller depreciation against the currencies of India’s major trading partners compared to its depreciation solely against the US dollar.

• The rupee’s trade-weighted REER for the 40-currency basket has increased in the last 20 years, indicating that the Rupee strengthened between 2004-05 and 2023-24.

Reasons for Indian Rupee to depreciate against US dollars:

• Trade Imbalance: Persistent trade deficits for India (as India imports more than the value of its exports) can put downward pressure on the rupee as more rupees are demanded to pay for imports compared to the dollars earned from exports.

• Capital Outflows: The rate of investment through FDI and FII has reduced in the last few years.

• Inflation Differentials: Higher inflation rates in India compared to the US can erode the purchasing power of the rupee, leading to depreciation against the dollar.

• Interest Rate Differentials: Lower interest rates in India relative to the US can reduce the attractiveness of Indian assets for foreign investors, resulting in capital outflows and rupee depreciation. Currently, the US interest rate is high.

Reasons for Indian Rupee to strengthen against the currencies of India’s major trading partners:

• Trade Surplus: India maintains a trade surplus with some of its major trading partners (including the USA. India has a trade surplus of over $24b with the US). It can lead to increased demand for the rupee, strengthening its value relative to those currencies.

• Positive Economic Outlook: Strong economic fundamentals and growth prospects in India compared to its trading partners can attract foreign investment, boosting demand for the rupee.

• Government Policies: Government policies aimed at stabilizing the currency and promoting economic growth can instil confidence in the rupee, leading to its appreciation against other currencies.

Implications of Currency Depreciation on the Indian Economy:

Positive Impacts:

• Boosts Exports: A cheaper rupee makes Indian exports more affordable for foreign buyers, potentially increasing demand and export earnings.

• Inward Remittances: A weaker rupee enables higher remittances from overseas workers, increasing disposable income in India.

Negative Impacts:

• Higher Import Costs: Imports become more expensive, leading to inflationary pressures and impacting purchasing power.

• Costlier Foreign Debt: Increased repayment burden on foreign debt due to the need for more rupees to settle debts.

• Discourages Foreign Investment: Depreciation signals economic instability, potentially dissuading foreign investors from investing in India.

Way Forward:

Enhancing Export Competitiveness, thereby Improving Indian Rupee Strength:

• Improved Infrastructure: Investments in transportation networks, ports, and customs clearance processes are crucial. Developing export promotion zones and specialized manufacturing zones is essential.

• Skill Development: Implementing skill development programs to enhance the availability of skilled labour in export-oriented industries.

• Technology Adoption: Incentivizing and promoting technology adoption, including automation, digitization, and Industry 4.0 technologies, to boost productivity, competitiveness, and innovation in the export sector.

• Internationalization of India Rupee

Insta Links:

• Internationalisation of rupee

Mains Links:

It is essential to approach the internationalisation of the rupee cautiously, considering the potential advantages and risks associated with it. Critically examine.

How would the recent phenomena of protectionism and currency manipulations in world trade affect the macroeconomic stability of India? (UPSC 2018)

Prelims lInk:

Q1. Which one of the following is not the most likely measure the Government/RBI takes to stop the slide of the Indian rupee? (UPSC 2019)

(a) Curbing imports of non-essential goods and promoting exports

(b) Encouraging Indian borrowers to issue rupee-denominated Masala Bonds

(d) Following an expansionary monetary policy

Ans: (d)

Q2. Consider the following statements: (UPSC 2019)

• The effect of devaluation of a currency is that it necessarily

• improves the competitiveness of the domestic exports in the foreign markets

• increases the foreign value of domestic currency

• improves the trade balance

Which of the above statements is/are correct?

(a) 1 only (b) 1 and 2 (c) 3 only (d) 2 and 3

Ans: (a)