Exchange Rate Management and Rupee Depreciation

An editorial discusses whether the Reserve Bank of India (RBI) should allow the Indian rupee to depreciate, intervening in the forex market only to curb excessive volatility. The pressures on the rupee are linked to global capital flow dynamics and the strengthening of the US dollar amid uncertain geopolitical circumstances.

Understanding Rupee Depreciation

• The depreciation of the rupee can influence foreign portfolio investors' decisions, as a sharp decline erodes the value of foreign assets in India.
• RBI actions signaling non-intervention may trigger capital outflows, exacerbating depreciation.
• Managing the depreciation requires ensuring that the "tipping point" is not crossed, which could lead to excessive capital outflows.

Challenges of Exchange Rate Management

The dynamics of rupee depreciation are influenced by India’s market-determined exchange rate policy and its capital account openness since the 1990s. The rupee’s value fluctuates based on volatile portfolio capital flows, leading to a long-term depreciation trend.

• From 2010-11 to 2023-24, the exchange rate has depreciated from INR 45.56 to INR 82.78 per USD, indicating a steady decline.
• Key factors for depreciation include higher domestic inflation rates compared to international markets, and a persistent foreign exchange deficit.

Structural Economic Challenges

• India's foreign exchange earnings from exports are consistently below its import expenditures, leading to a deficit economy relying on capital inflows.
• The current account deficit, driven by trade imbalances, highlights India’s lack of competitiveness in manufactured exports.

Vulnerability to Currency Crises

The liberalization of capital flows has exposed the Indian economy to potential currency crises characterized by sudden, sharp depreciations. India has managed to avoid such crises so far, a testimony to its exchange rate management strategy.