Why in News?

RBI appears to have eased its control over the rupee, allowing it to depreciate against the US dollar over the last month.

This marks a departure from its earlier stance of tightly managing the rupee to curb sharp declines, a strategy prominent until late 2024.

What’s in Today’s Article?

• Key Developments in Rupee Depreciation
• Impact of Depreciation
• Factors Influencing the Rupee’s Future
• Conclusion

Key Developments in Rupee Depreciation:

• Significant depreciation:
  • The rupee, which hovered around 84-85 per dollar, hit its historic low of 86.70 on January 13, 2025, marking its steepest single-day fall in two years.
  • Since November 1, 2024, the rupee has depreciated by 2.6%.
• Possible shift in RBI’s strategy:
  • The RBI’s reduced intervention points to an increased tolerance for rupee depreciation, aligning it with market forces and easing pressure on reserves.
  • Analysts suggest the RBI’s approach of allowing a wider range for the rupee is prudent, reducing resource expenditure.
  • Market experts, however, believe it is too early to attribute this change to the new RBI Governor, Sanjay Malhotra, who took charge on December 11, 2024.
• Reduced intervention:
  • The rupee’s fall indicates a potential recalibration in the RBI’s intervention strategy, driven by the strengthening dollar and the overvaluation of the real effective exchange rate (REER).
  • REER is a measure of a country's currency value relative to a group of other currencies, adjusted for inflation. It's used to assess a country's external balance and economic health.

Impact of Depreciation:

• Forex reserves:
  • India’s foreign exchange reserves declined by $79 billion since September 2024 to $625.87 billion by January 10, 2025.
  • The fall was attributed to dollar sales to manage the rupee and foreign investor withdrawals amounting to over ₹1,43,000 crore.
• Market liquidity deficit: Strong RBI intervention since Q4 FY24 caused a drain in domestic liquidity, pushing the system into deficit despite efforts like cash reserve ratio (CRR) cuts and bond purchases.
• Inflationary concerns: A weaker rupee may exacerbate imported inflation, especially for oil products, adding to inflationary pressures projected at 4.5% for Q4 FY24.

Factors Influencing the Rupee’s Future:

• Dollar strength:
  • The rupee’s trajectory depends on whether the US dollar strengthens further or stabilizes.
  • Expectations hinge on the impact of Donald Trump’s presidency, with potential policy shifts on immigration, taxes, and tariffs influencing the dollar’s strength.
• Predicted levels of rupee: Analysts expect the rupee to depreciate further to around 87 per dollar by March 2025, depending on global market dynamics and Trump’s policy actions.

Conclusion:

• The RBI’s recalibrated stance on the rupee reflects a strategic shift to balance market stability and resource conservation.
• While the long-term implications remain uncertain, this approach could allow for better alignment with global currency trends while addressing liquidity concerns domestically.