Why in News?

• The Indian rupee has witnessed a sharp depreciation against the U.S. dollar, with the exchange rate crossing ₹96 per dollar in May 2026 compared to around ₹85 a year earlier.
• The decline has revived debates over the strength of India’s economy, the sustainability of external balances, and the appropriate role of the Reserve Bank of India (RBI) in managing exchange rate volatility.

What’s in Today’s Article?

• Understanding Exchange Rate Dynamics
• Trade Deficit and Current Account Pressure
• Role of Capital Flows
• Historical Episodes of Sharp Rupee Depreciation
• Economic Impact of Rupee Depreciation
• RBI’s Role in Managing the Rupee
• Debate: Defend the Rupee or Let It Adjust?

Understanding Exchange Rate Dynamics:

• Exchange rate: It refers to the value of one currency relative to another. In a market-driven system, the rupee’s value depends on the demand and supply of rupees vis-à-vis foreign currencies, especially the U.S. dollar.
• Factors increasing demand for Rupee:
  • Exports of goods and services: Foreign buyers exchange dollars for rupees to pay Indian exporters.
  • Remittances: From Indians working abroad.
  • Foreign investments: Into Indian markets and businesses.
• Factors reducing demand for Rupee: Imports, especially crude oil. Foreign travel and education expenses. Capital outflows, where investors convert rupees into dollars and move funds abroad.

Trade Deficit and Current Account Pressure:

• India consistently runs a merchandise trade deficit because imports exceed exports, particularly due to dependence on crude oil, electronics, gold, and industrial inputs.
• Although India earns substantial foreign exchange through IT and software services, remittances from migrant workers, and other invisibles, these inflows only partially offset the merchandise trade deficit.
• Consequently, India often faces a Current Account Deficit (CAD). A persistent CAD means more rupees are exchanged for dollars than vice versa, and as a result demand for dollars rises, and rupee depreciates.

Role of Capital Flows:

• India finances its CAD through the Capital Account, mainly via: Foreign Direct Investment (FDI), Foreign Portfolio Investment (FPI), and external borrowings.
• Difference between FDI and FPI:
• 
• Why do capital outflows hurt the Rupee?
  • When foreign investors withdraw investments, they sell rupee assets, convert rupees into dollars, increase dollar demand, and trigger rupee depreciation.
  • Recent rupee weakness has been linked to rising U.S. interest rates, global geopolitical tensions, and flight of capital toward safer assets.

Historical Episodes of Sharp Rupee Depreciation:

• Major periods of rupee decline include: 2013 “Taper Tantrum”, 2018 emerging market stress, COVID-19 shock in 2020, 2022 global monetary tightening, and 2024-26 geopolitical and oil price shocks.
• A common feature across these episodes has been trade account deterioration, FPI outflows, and global uncertainty.

Economic Impact of Rupee Depreciation:

• Negative effects:
  • Costlier imports: As India imports most of its crude oil, a weaker rupee increases fuel prices, inflationary pressures, and input costs for industries.
    • Example: A $100 barrel of oil costs: ₹8,500 at ₹85/$, ₹9,600 at ₹96/$.
  • Imported inflation: Higher import costs raise prices of fertilisers, electronics, industrial machinery, and edible oils.
  • Investment concerns: Depreciation reduces returns for foreign investors in dollar terms, discouraging future capital inflows.
• Can a weak rupee boost exports?
  • Economic theory suggests depreciation improves export competitiveness because Indian goods become cheaper abroad.
  • However, India faces structural limitations.
    • High import content in exports: Many exports depend on imported inputs. Costlier imports offset export gains.
    • Price-taking nature of exports: India competes with countries like Bangladesh and Vietnam. Foreign buyers may force Indian exporters to lower dollar prices.
    • Supply-side bottlenecks: Logistics costs, infrastructure gaps, and limited manufacturing depth.
  • Hence, depreciation alone may not significantly improve export earnings.

RBI’s Role in Managing the Rupee:

• The RBI intervenes in forex markets to prevent excessive volatility, not to defend any fixed exchange rate.
• Mechanism of intervention: When the rupee falls sharply RBI sells dollars from forex reserves, purchases rupees, raises rupee demand, and moderates depreciation.
• Forex reserves as strategic buffer:
  • India’s forex reserves stood at about $691 billion in March 2026, providing around 10.8 months of import cover.
  • These reserves ensure payment for essential imports, provide confidence to markets, and help resist speculative attacks.
• Limits of RBI intervention:
  • Finite forex reserves: Continuous intervention can deplete reserves below safe import-cover levels.
  • Nature of India’s forex: Unlike China’s export-driven reserves, much of India’s forex comes from volatile capital inflows rather than trade surpluses.
  • Delayed adjustment risk: Artificially stabilising the rupee for long periods may postpone necessary corrections, leading to sharper future depreciation.

Debate: Defend the Rupee or Let It Adjust?

• Arguments for allowing depreciation: Conserves forex reserves, improves export competitiveness, discourages excessive imports, and allows market-based adjustment.
• Arguments for RBI defence: Prevents panic and speculation, ensures orderly currency movement, protects financial stability, and reduces inflationary shocks.
• Risks of free fall: Unchecked depreciation may trigger further speculation, encourage importers to hoard dollars, reduce foreign investment confidence, create a vicious cycle of depreciation, etc.

Context

• India has achieved remarkable progress in improving access to drinking water through the Jal Jeevan Mission, which has provided tap water connections to nearly 80% of rural households.
• Urban areas, despite facing periodic shortages, generally receive intermittent water supply.
• However, between the rural and urban landscape lies a neglected missing middle, the rapidly expanding peri-urban regions.
• These areas, where villages gradually transform into industrial and residential settlements, face severe challenges related to water supply, sanitation, and governance.
• The absence of proper administrative recognition has made peri-urban India one of the most vulnerable regions in the country’s development process.

Growth of Peri-Urban India

• Rapid Urbanisation and Census Towns
  • India’s rapid urbanisation is evident in the sharp rise of Census towns, which increased from 1,362 to 3,784 over the last two decades.
  • These settlements are no longer purely rural, yet they have not been fully recognised as urban centres.
  • As a result, they remain trapped between rural administration and urban governance systems.
• Governance Vacuum
  • The lack of institutional clarity has created a major governance crisis. Peri-urban residents often pay urban-level costs but receive inadequate services.
  • In Gurugram, for instance, peri-urban areas were brought under municipal administration after rural governance structures were abolished.
  • However, weak civic management has left residents with poor water and sanitation facilities.
  • Similarly, residents of Rawta village near Delhi receive water only on alternate days and during late-night hours.
  • Such irregular supply forces families to sacrifice sleep for collecting water and increases dependence on private water vendors.

Environmental and Social Consequences

• Groundwater Contamination
  • Poor waste management has severely damaged the environment in peri-urban areas.
  • In peri-urban Hyderabad, toxic leachate from dumping sites has contaminated groundwater, creating major health risks for local communities.
• Unequal Water Distribution
  • Urban expansion often diverts resources away from rural and peri-urban populations.
  • Water from the Bisalpur dam, originally intended for irrigation in Tonk and Sawai Madhopur, is increasingly redirected to meet Jaipur’s urban demands.
  • Consequently, downstream farmers suffer from reduced water access and declining agricultural productivity.
• Public Health Risks
  • The lack of proper sanitation systems has intensified public health concerns. Nearly 40 million urban households rely on septic tanks and other on-site sanitation systems.
  • However, irregular desludging and illegal dumping of untreated septage into rivers and fields contribute to pollution and disease, undermining the achievements of the Swachh Bharat Mission.

Future Challenges

• Expanding Urban Demand
  • India’s future urban growth will place enormous pressure on existing infrastructure.
  • By 2047, the country is expected to require 230 million new housing units and nearly 500 new cities. Today’s peri-urban regions will become tomorrow’s urban centres.
• Threat to Water Security
  • Without proper planning, India may face worsening water scarcity, environmental degradation, and rising inequality.
  • Peri-urban areas therefore hold the key to the country’s future water security and sustainable development.

Solutions and Policy Recommendations

• Strengthening Governance
  • The first step is to address the administrative vacuum through the establishment of Nagar Panchayats, as envisioned under the 74th Constitutional Amendment.
  • Legal recognition must be accompanied by stronger institutional capacity and accountability.
  • Successful local initiatives, such as the collaborative platform in Sultanpur village, demonstrate that cooperation between authorities, engineers, and residents can improve governance.
• Protecting Water Sources
  • Long-term sustainability requires protecting drinking water sources from encroachment, pollution, and waste dumping.
  • Community-based sanitary inspections, already successful in Maharashtra, can help strengthen local participation in water management.
• Swachh Bharat Mission 3.0
  • A specialised Swachh Bharat Mission 3.0 should focus on peri-urban sanitation.
  • The programme should prioritise faecal sludge management, treatment plants in underserved regions, GPS-monitored desludging trucks, and mini-cesspool vehicles for narrow settlements.
  • Integrating sanitation costs into monthly water bills through a small levy could also improve financial sustainability.
• Decentralised Wastewater Treatment
  • India must also promote decentralised wastewater treatment technologies.
  • Companies such as Indra Water and Tigreen have developed systems capable of recycling more than 95% of used water while requiring minimal land and energy.
  • These technologies need stronger policy support, financial incentives, and government procurement mechanisms to expand effectively.
• Strategic Financing
  • Peri-urban water infrastructure should be treated as strategic infrastructure.
  • Blended financing models, such as Uttarakhand’s partnership-based approach combining state support with concessional international loans, can help fund sustainable water and sanitation systems.

Conclusion

• Peri-urban India represents the missing middle in the country’s development story.
• Despite its growing demographic and economic importance, it continues to suffer from weak governance, inadequate infrastructure, and environmental degradation.
• Challenges such as irregular water supply, groundwater contamination, poor sanitation, and unequal resource distribution threaten both public health and long-term sustainability.
• However, with effective governance reforms, innovative technologies, sustainable financing, and community participation, peri-urban India can transform into a water-secure, inclusive, and sustainable urban future.

Context

• India’s fiscal federalism is designed to balance financial relations between the Centre and the States.
• The Finance Commission (FC) plays a vital role in correcting vertical imbalance between revenue powers and expenditure responsibilities, and horizontal imbalance among States with differing economic capacities.
• The 16th Finance Commission retained the States’ 41% vertical devolution share and continued to prioritise equity-based redistribution.
• However, this has intensified debates between economically stronger and fiscally weaker States over fairness, efficiency, and fiscal autonomy.

The Constitutional Role of the Finance Commission

• The FC distributes the Union’s tax revenues between the Centre and States and among States themselves.
• Historically, the Commission has focused on reducing regional disparities through criteria such as income distance, population, and demographic performance.
• Poorer States receive higher transfers to ensure balanced development and equal access to public services.
• The 16th FC largely continued this redistributive model, but economically stronger States argued that the present system disproportionately rewards weaker States while reducing incentives for growth and efficient governance.

Fiscal Pressures Faced by States

• Impact of GST and the Pandemic
  • The introduction of the Goods and Services Tax (GST) reduced States’ independent taxation powers by subsuming several State taxes into a unified framework.
  • At the same time, the COVID-19 pandemic increased expenditure burdens while reducing revenues, causing rising public debt and shrinking fiscal space.
• Expansion of Centrally Sponsored Schemes (CSS)
  • The growing role of CSS has further weakened fiscal autonomy.
  • Programmes such as the National Rural Employment Guarantee programme require States to bear a significant share of expenditure, limiting their spending flexibility.
• Declining Fiscal Autonomy
  • States also criticised the increasing use of cesses and surcharges, which are excluded from the divisible pool and therefore not shared with States.
  • Since these now exceed 15% of gross tax revenues, several States demanded either their inclusion in the divisible pool or a cap of 8–10%.
  • In addition, the Centre earns substantial non-tax revenues from natural resources, asset monetisation, and transfers from the Reserve Bank of India (RBI).

Equity versus Efficiency in Fiscal Transfers

• Equity-Based Redistribution
  • The 16th FC gave the highest weight, 42.5%, to income distance, ensuring larger transfers to poorer States such as Uttar Pradesh, Bihar, Madhya Pradesh, and West Bengal.
  • This approach reflects the principle of equalising developmental opportunities across the country.
• Criticism from Better-Performing States
  • The combined share of southern States, Andhra Pradesh, Karnataka, Kerala, and Tamil Nadu, declined significantly over successive FC periods, while major beneficiary States gained larger shares.
  • Southern States contribute disproportionately to national GDP, industrial output, and tax revenues, yet receive relatively lower transfers.
  • This has created concerns about imbalance in the federal structure.

Limitations of the Existing Transfer System

• Persistent Public Service Disparities
  • For example, Bihar’s spending on healthcare and elementary education remains far below that of smaller States such as Arunachal Pradesh and Sikkim.
  • This shows that unconditional transfers alone cannot guarantee better governance or improved public service delivery.
• Weak Incentives for Fiscal Discipline
  • The current system may weaken incentives for revenue mobilisation, fiscal responsibility, and efficient administration.
  • Better-performing States argue that greater importance should be given to fiscal effort, governance quality, and economic productivity rather than relying mainly on redistributive criteria.

Evaluation of the 16th Finance Commission’s Recommendations

• Criteria and Weight Distribution
  • The Commission assigned:
    • 42.5% to income distance,
    • 17.5% to population,
    • 10% each to area, forest cover, demographic criterion, and GDP contribution.
  • Although States’ contribution to national GDP replaced tax effort, the FC used a square-root transformation instead of actual GSDP shares, reducing the advantage of economically larger States such as Maharashtra, Tamil Nadu, and Karnataka.
• Limited Shift toward Efficiency
  • The balance between equity and efficiency changed only slightly:
    • 15th FC: 75% equity and 25% efficiency.
    • 16th FC: 70% equity and 30% efficiency.
  • As a result, poorer States continued receiving larger shares, while stronger States achieved only marginal gains.

Political Economy and the Future of Fiscal Federalism

• States with larger parliamentary representation are often fiscally weaker but politically influential.
• This issue may intensify after delimitation, increasing concerns among southern States regarding both political and financial marginalisation.
• Future Finance Commissions should therefore focus more on fiscal capacity, governance outcomes, and data-driven methods such as Principal Component Analysis (PCA) to ensure a more balanced and transparent devolution system.

Conclusion

• The debate surrounding the 16th FC reflects the broader challenge of balancing redistribution with economic efficiency in India’s federal structure.
• While equity remains essential for national integration, excessive reliance on equalisation may discourage fiscal discipline and productive governance.
• A sustainable model of fiscal federalism must combine support for weaker States with incentives for growth, accountability, and efficient administration.

About Public Accounts Committee:

• It is the oldest parliamentary committee in India which was established in 1921.
• It is constituted every year.
• The Chairperson is appointed by the Speaker from amongst its Members of Lok Sabha.
• The Speaker, for the first time, appointed a Member of the Opposition as the Chairperson of the Committee for 1967-68.
• Purpose: Audits the revenue and expenditure of the Government of India to ensure public funds are spent efficiently and legally.
• Functions of PAC:
  • It examines the CAG audit report on government expenditure.
  • It ensures money sanctioned by Parliament is spent properly.
  • It investigates financial irregularities, losses, and inefficiencies in government spending.
• Members:
  • It consists of 22 members (15 from Lok Sabha, 7 from Rajya Sabha).
  • Chairperson: A Lok Sabha MP, traditionally from the Opposition.
  • Term: One year.
  • Ministers cannot be members of the PAC.

About BHAVYA Scheme:

• BHAVYA (Bharat Audyogik Vikas Yojna) is a Central Sector Scheme aimed at developing investment-ready, world-class industrial parks across the country.
• The major focus of the Scheme is on creation of
  • Investment-ready industrial ecosystems with plug-and-play infrastructure, multimodal logistics connectivity, reliable utility systems, worker-support infrastructure, digital governance systems, and sustainable development features.
• Time Period: Six years from 2026-27 to 2031-32
• Features of BHAVYA Scheme:
  • It has been designed to support the Centre’s Make in India and PM Gati Shakti programmes by creating integrated, investment-ready manufacturing zones equipped with plug-and-play infrastructure and multimodal logistics connectivity.
  • It provides for development of both greenfield and eligible brownfield industrial parks.
  • Minimum land requirements have been fixed at 100 acres for non-hilly states and 25 acres for hilly states, northeastern states, Union Territories, and smaller states.
  • Implementation: It will be undertaken through Special Purpose Vehicles (SPVs) incorporated under the Companies Act, 2013.

About Buxa Tiger Reserve:

• Location: It is located in the Jalpaiguri district of West Bengal.
• Its northern boundary runs along the international border with Bhutan.
• The fragile “Terai Eco-System” constitutes a part of this reserve.
• It serves as an international corridor for elephant migration between India and Bhutan.
• Corridor Connectivity
  • The reserve has corridor connectivity across the border with the forests of Bhutan in the North, on the East it has linkages with the Kochugaon forests, Manas Tiger Reserve and on the West with the Jaldapara National Park.
• Rivers: It is drained by two rivers, namely the River Raidak and the River Jayanti.
• Vegetation: The forests of the reserve can be broadly classified as the ‘Moist Tropical Forest’.
• Flora: Some of the important species are Sal, Champa, Gamar, Simul, and Chikrasi.
• Fauna: The main species include the Tiger, elephant, leopard cat, gaur, wild boar, sambar, hog deer, Chinese pangolin, etc.

About Idu Mishmi Tribe:

• It is one of the tribal groups who have been living primarily in the Dibang Valley, lower Dibang, and Lohit districts of Arunachal Pradesh.
• They primarily live in Mishmi Hills, bordering Tibet in Arunachal Pradesh.
• They can be distinctively identified by their typical hairstyle, distinctive customs and artistic pattern embedded on their clothes.
• Occupation: They are known for their weaving and craftsmanship skills.
• Language: Their language, called ‘Idu Mishmi’, is considered endangered by UNESCO.
• Relationship with nature:
  • Traditionally animists, the tribe has strong ties with the region’s rich flora and fauna. 
  • Tigers are especially important to the Idu Mishmis — according to Idu mythology, they were born to the same mother, and thus, tigers are their “elder brothers”.
  • Iyu-ena’: It is a strict belief system of myths and taboos that restrict them from hunting many animals, including a complete prohibition on killing tigers.
• Festivals: They celebrate festivals such as Reh and Ke-Meh-Ha.
• They brew local rice beer called Ebu.
• Society: The Idu-Mishmi society is patriarchal and patrilineal. The property is inherited by the son from the father. 

About Asian Infrastructure Investment Bank:

• It is a multilateral development bank established in
• Objective: It focuses on promoting sustainable economic growth, enhancing regional connectivity, and mobilizing both public and private capital for infrastructure investments. 
• Headquarters: Beijing, China
• Membership: It has now grown to 111 approved members
  • India is a Founding Member of AIIB and the second-largest shareholder after China. 
• Governance:
  • It is headed by a Board of Governors composed of one Governor and one Alternate Governor appointed by each of the member countries.
  • A non-resident Board of Directors is responsible for the direction and management of the Bank, such as the Bank’s strategy, annual plan and budget and establishing policies and oversight procedures.
  • The bank staff is headed by a President who is elected by AIIB shareholders for a five-year term and is eligible for re-election once.