Rupee Emerges as the Second Worst-Performing Currency in Asia: Causes and Implications

The Indian rupee has recently garnered attention for an unfortunate milestone: it has become the second worst-performing currency in Asia. This decline has sparked concern among economists, policymakers, and market participants, as it raises questions about the economic trajectory of one of the world’s fastest-growing economies. While the rupee’s performance is shaped by various global and domestic factors, its continued depreciation has wide-ranging implications for India’s economy, businesses, and consumers.

Understanding the Decline

As of 2024, the Indian rupee has witnessed a significant drop in value against the US dollar, underperforming most of its Asian counterparts. The depreciation is measured against a basket of global currencies, with the US dollar acting as the benchmark due to its global dominance in trade and financial transactions. A combination of external pressures, including a strong dollar, rising oil prices, and global monetary tightening, has played a critical role in the rupee’s performance.

The rupee’s fall can be primarily attributed to three key factors:

1. Strength of the US Dollar: The US dollar has remained resilient due to the Federal Reserve’s tight monetary policy aimed at controlling inflation. Higher interest rates in the United States attract global investors seeking better returns, leading to a capital outflow from emerging markets like India. This exerts downward pressure on the rupee.
2. Oil Price Volatility: India is heavily dependent on oil imports, which account for a significant portion of its trade deficit. Rising crude oil prices increase the demand for dollars, worsening the rupee’s exchange rate. With global oil markets facing geopolitical uncertainties, this trend has amplified the rupee’s struggles.
3. Current Account Deficit (CAD): India’s widening current account deficit, fueled by a surge in imports and muted export growth, is another contributor to the rupee’s underperformance. A high CAD indicates that the country is spending more on foreign trade than it is earning, which necessitates the use of foreign exchange reserves, further pressuring the currency.

Comparison with Other Asian Currencies

While several Asian currencies have faced challenges in recent times due to similar external factors, the rupee’s performance has been notably weaker. The currencies of nations such as Indonesia, Thailand, and the Philippines have also depreciated, but their respective governments have employed aggressive interventions, including forex reserve management and monetary policy adjustments, to stabilize their economies.

The Indian rupee’s underperformance, second only to the Japanese yen in Asia, highlights vulnerabilities specific to the Indian economy. While the yen’s decline has been attributed to Japan’s ultra-loose monetary policy, the rupee’s slide stems from both external and structural domestic issues.

Implications of the Depreciation

The rupee’s depreciation has far-reaching consequences for India’s economy. Some of the most critical implications include:

1. Inflationary Pressures: A weaker rupee makes imports, particularly oil and raw materials, more expensive. This, in turn, fuels domestic inflation, affecting the cost of goods and services. For a developing economy like India, where a significant portion of the population is price-sensitive, higher inflation poses a considerable risk to purchasing power and living standards.
2. Impact on Businesses: Import-heavy industries such as manufacturing, chemicals, and electronics face increased costs due to a weaker currency. Small and medium enterprises (SMEs), which have limited hedging capabilities against forex fluctuations, are particularly vulnerable.
3. Pressure on Forex Reserves: To stabilize the rupee, the Reserve Bank of India (RBI) often intervenes by selling dollars from its foreign exchange reserves. However, continuous interventions can deplete reserves, limiting the central bank’s ability to manage future economic shocks.
4. External Debt Burden: A depreciating rupee increases the cost of servicing India’s external debt, which is denominated in dollars. This adds to the fiscal strain and constrains the government’s spending capacity.
5. Export Competitiveness: On the positive side, a weaker rupee can enhance the competitiveness of Indian exports by making them cheaper in global markets. However, this advantage is often offset by rising input costs and subdued global demand.

Policy Responses and the Way Forward

To address the rupee’s underperformance, the Indian government and the RBI must adopt a multi-pronged strategy. Key measures could include:

1. Strengthening Forex Reserves: The RBI can continue to build its foreign exchange reserves during periods of dollar inflows, enhancing its ability to manage future currency volatility.
2. Managing the Trade Deficit: Encouraging domestic manufacturing and reducing reliance on imports through initiatives like Make in India can help narrow the trade deficit. Simultaneously, promoting exports in high-value sectors such as technology and pharmaceuticals is crucial.
3. Attracting Foreign Investments: Creating a conducive environment for foreign direct investment (FDI) and portfolio investments can help sustain capital inflows, supporting the rupee.
4. Monetary Policy Coordination: While controlling inflation remains a priority, a balanced approach to interest rate management is needed to ensure that growth is not compromised.
5. Diversifying Energy Sources: Reducing dependency on oil imports by accelerating the adoption of renewable energy can mitigate the impact of global oil price shocks on the rupee.

Conclusion

The Indian rupee’s emergence as the second worst-performing currency in Asia underscores significant challenges, both external and domestic. While global economic conditions have exacerbated its decline, addressing structural weaknesses within the Indian economy is critical to reversing the trend. Policymakers must adopt a mix of short-term interventions and long-term reforms to restore stability to the rupee and safeguard the broader economic landscape. As the world navigates uncertain economic waters, India’s response to this currency crisis will serve as a litmus test for its resilience and adaptability.