The significance of a nation’s currency exchange rate cannot be overstated. It serves as a vital barometer of economic health and global competitiveness, affecting everything from inflation and trade balances to foreign investment and citizens’ purchasing power.

In the case of India, the depreciation of the rupee against the US dollar has garnered much attention. Last month, the exchange rate crossed Rs 85 to 1 USD, compared to Rs 83 in April 2024 and Rs 61 a decade ago When Narendra Modi become prime minister in 2014. This steady decline raises concerns and offers lessons about India’s economic trajectory and policy priorities.

The Importance of Exchange Rates Exchange rates influence a country’s economic stability and are a key determinant of trade dynamics. A weaker rupee makes imports more expensive and exports more competitive. For a country like India, which relies heavily on oil imports, a depreciating rupee significantly increases the cost of energy, driving inflation and affecting household budgets. Additionally, a weaker currency can make foreign education and travel costlier for Indian citizens.

On the flip side, depreciation can benefit exporters and sectors such as IT and pharmaceuticals, where revenues are dollar-denominated. It also makes India an attractive destination for foreign investors looking to capitalize on cheaper labour and production costs. However, these benefits often come with limitations. For instance, if the broader economic environment is perceived as unstable, foreign investors may hesitate to commit, regardless of currency advantages.

Why Is the Rupee Depreciating? The rupee’s decline is attributable to several factors. First, the persistent trade deficit — where imports exceed exports — exerts downward pressure on the currency. Second, global monetary tightening by the US Federal Reserve has strengthened the dollar, making other currencies, including the rupee, relatively weaker. Third, geopolitical tensions and supply chain disruptions have increased demand for safe-haven currencies like the dollar.

Domestically, structural issues such as high inflation, a lack of diversification in exports, and reliance on imported goods exacerbate the problem. Policies aimed at fostering self-reliance, like “Make in India,” have yet to fully bear fruit in reducing import dependency.

Government’s Role and Challenges: Governments and central banks play a crucial role in managing exchange rates. Through measures like intervening in foreign exchange markets or adjusting interest rates, they attempt to stabilize currency fluctuations. In India’s case, the Reserve Bank of India (RBI) has intervened to prevent excessive volatility. However, such interventions are not without cost, as they deplete foreign exchange reserves.

Fiscal and monetary policies also influence exchange rates. For example, attracting foreign investment through liberalized policies or controlling inflation through prudent fiscal management can help stabilize the rupee. However, excessive reliance on short-term measures, such as borrowing or imposing trade restrictions, can undermine long-term growth.

Broader Implications The depreciation of the rupee reflects deeper economic challenges. While a weaker currency can sometimes be part of a growth strategy, persistent depreciation often signals structural weaknesses. Addressing these requires a multi-faceted approach: boosting exports, reducing import dependency, managing inflation, and ensuring macroeconomic stability.

Additionally, a weak rupee can have geopolitical ramifications, as it affects India’s standing in global markets and negotiations. For instance, a strong and stable currency is often seen as a mark of economic resilience and governance.

The rupee’s exchange rate is not merely a number; it is a reflection of India’s economic policies, global positioning, and aspirations. While short-term fluctuations are inevitable, the long-term trend of depreciation underscores the need for structural reforms and proactive policymaking. As India seeks to establish itself as a global economic powerhouse, stabilizing and strengthening its currency should be a priority. Addressing the underlying issues with a blend of innovation, policy clarity, and global collaboration will be key to ensuring economic resilience and prosperity.