MANAGING CURRENCY DEPRECIATION

Why In News?

The Indian rupee hit a record low by crossing 96 per dollar due to the West Asia crisis, sparking concerns among policymakers about it breaching the 100-mark.

What is Currency Depreciation?

Currency depreciation refers to the decline in the value of a domestic currency (such as the Indian Rupee) relative to a foreign currency (like the US Dollar).

Market forces of supply and demand determine this fall in a floating exchange rate system.

Why Do Currencies Depreciate?

Surging Crude Oil Prices: Since India imports over 85% of  crude oil requirement, elevated prices—such as Brent crude crossing $111 per barrel—sharply increase the demand for dollars to pay import bills.

Foreign Capital Outflows: Foreign institutional investors (FIIs) sell domestic equities during periods of global uncertainty. 

• When foreign investors liquidate their assets, they convert rupees into dollars, creating downward pressure on the currency.
• Foreign Portfolio Investors pulled out a ₹2.62 lakh crore  in 2026 so far. (Source: National Securities Depository Limited).

Geopolitical Instability: Global conflicts, such as the US-Iran tensions and disruptions in the Strait of Hormuz, trigger "flight to safety". 

• Investors rush to acquire the US dollar, which weakens emerging market currencies like the Indian Rupee.

Narrowing Yield Differentials: When the US Federal Reserve maintains elevated interest rates, the yield gap between Indian and US government bonds shrinks. 

• Promoting investors to shift capital from India to the "risk-free" safety of US Treasury assets.

Trade Deficits and Tariffs: A widening Current Account Deficit (CAD) and external trade pressures, such as the US imposing 50% tariffs on select Indian goods, reduce export competitiveness and strain the currency.

Why is Currency Depreciation a Concern for India?

Imported Inflation

A weaker rupee inflates the landed cost of imports like crude oil, gold, and electronic components. If crude oil prices exceed baseline assumptions by 10%, domestic inflation can surge by 30 basis points. (Source: RBI)

Widening Current Account Deficit

Inflated import bills widen the trade deficit, placing structural strains on the Indian economy.

Corporate Margin Squeeze

Import-reliant sectors, including aviation, oil marketing companies, face margin pressures. Companies holding external commercial borrowings (ECBs) suddenly face heavily inflated repayment costs.

Negative Feedback Loop for Investors

Currency depreciation erodes the dollar-adjusted returns for existing foreign investors. This erosion triggers panic selling, driving a self-sustaining cycle of capital flight and currency weakness.

How India Manages Currency Depreciation?

Executes Spot Market Interventions

The Reserve Bank of India (RBI) directly sells dollars from its foreign exchange reserves (specifically Foreign Currency Assets) in the spot market to absorb sudden dollar demand and arrest immediate currency depreciation.

Sterilizes Excess Liquidity

The RBI deploys the Market Stabilisation Scheme (MSS) and conducts Open Market Operations (OMOs) to withdraw surplus rupees and prevent domestic inflation after buying dollars.

Tightens the LAF Corridor

The central bank manipulates the Liquidity Adjustment Facility (LAF) to raise overnight call money rates, which makes borrowing rupees to short the currency prohibitively expensive for speculators.

Leverages the Forward Market

The RBI sells dollars in the forward market to manage future dollar liquidity and reassure markets without instantly depleting physical spot reserves.

Conducts USD/INR Swap Auctions

The central bank executes USD/INR Buy/Sell swap auctions (e.g., $5 billion for three years) to lower corporate hedging costs and inject durable rupee liquidity into the banking system.

Attracts NRI Deposits via FCNR-B

The RBI opens FCNR-B (Foreign Currency Non-Resident - Bank) swap windows to offer banks subsidized hedging rates, which successfully incentivizes massive foreign currency inflows from non-resident Indians during severe crises.

Enforces Strict Speculation Curbs

The RBI caps banks' net open positions in the onshore currency market at a strict maximum of $100 million per day to force lenders to reduce exposure and prevent large, one-sided bets against the Rupee.

Monitors the REER

Tracking the Real Effective Exchange Rate (REER) to measure currency overvaluation and ensure interventions protect India's fundamental export competitiveness.

Drives National Conservation Measures

Prime Minister urges citizens and businesses to adopt fuel conservation measures, expand work-from-home (WFH) arrangements, and curb non-essential imports to directly reduce energy demand and protect the import bill.

How Other Economies Managed Currency Pressures?

Executing Aggressive Monetary Tightening

During the severe oil shocks of the 1970s, global central banks deployed aggressive monetary tightening and raised interest rates to combat double-digit inflation triggered by energy supply disruptions.

Prioritizing Economic Growth Over Currency Defense

During the 2007–2008 global financial crisis, central banks cut interest rates to stimulate economic activity, choosing to support growth rather than  defend their currencies against inflation spikes.

Holding Rates Steady Amid Geopolitical Crises

In response to the 2026 West Asia conflict, institutions like the South African Reserve Bank (SARB) hold rates steady and reassess inflation outlooks, while the US Federal Reserve exercises extreme caution, delaying rate cuts until 2027 to manage global inflation expectations.

Way Forward For India

Fast-Track Trade Agreements

Finalize the pending US-India trade deal to eliminate market uncertainty, restore investor confidence, and revive foreign portfolio inflows.

Build Structural Self-Reliance

Promote domestic manufacturing and self-reliance to reduce India's  dependence on non-essential imports and permanently conserve foreign exchange reserves.

Track Macroeconomic Indicators

Monitor key technical indicators preemptively, specifically the Real Effective Exchange Rate (REER) for currency overvaluation, US 10-Year Treasury Yields for capital flight risks, and the RBI's net forward position for capital account stress.

Reallocate Capital to Quality Assets

Shift investments away from heavily leveraged companies and import-dependent firms. Redirect capital toward quality businesses that demonstrate strong pricing power and the ability to deliver growth despite global shocks.

Execute Opportunistic Reserve Accumulation

Accumulate reserves opportunistically and procure gold whenever global conditions temporarily stabilize to protect export competitiveness and rebuild the defensive war chest.

Diversify Investment Portfolios

Allocate 10% to 15% of investment portfolios to gold to hedge against imported inflation. Diversify broadly across regions and asset classes to withstand uncertainty and maintain cash-flow planning.

Implement National Conservation Measures

Adopt strict fuel conservation measures, expand work-from-home (WFH) arrangements, and reduce non-essential travel and imports to directly safeguard India's reserves.

Conclusion

India must blend proactive monetary interventions with deep structural reforms—like energy self-reliance and domestic manufacturing—to insulate the economy against volatile global currency shocks.

Source: REPUBLICWORLD