By Dr. Nilanjan Banik
On January 13, 2025, the rupee recorded its sharpest single-day decline in nearly two years, finishing the session 58 paise lower at a historic low of Rs 86.62 against the US dollar. Numerous commentaries are now emerging in popular media, expressing concern that a weakened Rupee could pose challenges for the Indian economy, particularly for Indian industries, as larger companies tend to borrow in dollars. A weaker Rupee also implies higher import costs, which could lead to a widening current account deficit (CAD). Basic macroeconomic theory suggests that a widening CAD will fuel domestic inflation by raising the price of imported crude oil. This could have secondary effects, including a decline in foreign exchange reserves and foreign institutional investors pulling out of the Indian stock market.
Interestingly, the depreciation of Rupee against the US dollar is not a recent phenomenon. Between 2005 and 2024, the Rupee has, on average, depreciated by around 3.5% annually. An analysis of long-term data suggests that the average annual depreciation of the Rupee was 0.4% between 2000 and 2004. However, the depreciation accelerated significantly after that, with the rupee depreciating on average by 3.4% annually between 2005 and 2014. This trend remained largely unchanged between 2015 and 2025, with the rupee depreciating on average by 3.5% annually.
Now what are the reasons for the Rupee to depreciate? First is inflation. If domestic inflation is higher than the US inflation, the Rupee is expected to depreciate against the dollar. Second is the asset market approach, which suggests that the value of the exchange rate depends on the inflow and outflow of capital into and from the domestic economy.
Historically, the US has a lower inflation rates than India. Much of the differential in inflation rates between the US and India can be explained by labour productivity alone, with more productive labour generating more real goods and services, thereby leading to lower inflation. According to ILO estimates for 2025, India is producing an output of US$ 25,431 per worker, significantly below America’s average of US$ 153,446 per worker. Additionally, with Trump’s promise of making the US economy great again, fund managers are pulling out of the Indian market, hoping that American assets and the dollar will strengthen and yield greater returns. Foreign fund managers sold equities worth Rs 1,13,858 crore through exchanges in October, with an additional Rs 41,872 crore of equities sold through exchanges in November 2024. Therefore, the depreciation of the Rupee is likely to continue, and one should not be overly concerned unless the annual rate of depreciation exceeds 4%.
Interestingly, contrary to popular belief, a weaker Rupee may not necessarily boost our merchandize exports. A look at our major tradable export items suggests these are income elastic, that is, they tend to perform well when there is an upsurge in foreign income. In case of India, there is a change in composition of exports from price sensitive items such as leather footwear, dairy products, beverages, textiles and apparel products, to more income sensitive items such as refined petroleum products, iron and steel, chemicals, machinery and transport equipment (engineering goods), and pearls and precious stones such as diamonds. For example, the share of refined petroleum products (high-speed diesel, motor spirit, aviation turbine fuel, naphtha, etc.) in India’s export basket increased dramatically from around 2% in 1993 to around 21% in 2023. In fact, India is now the the second-largest exporter of refined petroleum in the world, with exports valued at $85 billion and a global market share of 12.6%.
Although the weakening Rupee helped improve the trade balance between 2000 and 2014, evidence of such a relationship has become increasingly weak in the years following 2014. Therefore, the fear that a weakening Rupee will increase India’s trade deficit may not be accurate. This relationship between exchange rate and merchandize trade deficit is becoming irrelevant due to the shift in Indian exports from price-sensitive to income-sensitive items. A prolonged Russia-Ukraine war and the onset of weak global economic growth, especially in the Eurozone, led to lower demand for income-elastic items, which make up a significant portion of India’s export basket. In China, India’s another major trading partner, GDP growth rate is likely to slow down from 8.1% in 2021 to below 5% in 2025. Additionally, Trump’s tariffs could pose a challenge for India’s exports. Tariffs may also reduce the US trade deficit, potentially leading to further appreciation of the dollar.
On the flip side, with Trump facilitating the end of the war in Gaza and potentially resolving the Russia-Ukraine conflict, the world economic order could be restored, leading to softer crude prices, higher global income, and a positive impact on our income-sensitive exports. A weaker Rupee will also makes India an attractive destination for setting up businesses, as Indian labour, land, and capital become relatively cheaper. The rapid growth of Global Capability Centres (GCCs) in India is a testament to this, with around 1700 GCCs now operating in the country.
Another significant beneficiary of a falling Rupee is the remittances from Indians working and settled abroad. India received over $111 billion in remittances in 2022, becoming the first country to ever reach that milestone. This figure is nearly 2.2 times higher than the $49 billion in FDI inflows India received in 2022. Finally, the all promising India’s software exports are likely to get benefitted from a weakening Rupee. In fact, when examining the largest component of India’s imports—mineral fuels, oils, and bituminous substances (HS Code 27)—the deficit in this category is offset by the proceeds from total services exports. That’s what makes India distinct from its South Asian peers, where their declining currencies are posing significant challenges to their long-term growth prospects. (IPA Service)
(The author is Professor, School of Management, Mahindra University).
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