Rupee Slips Vs US Dollar: Good, Bad Or Ugly? — Profit Explains

Depreciation of a country’s currency against others, especially the US Dollar, makes the export cheaper in the international markets. This, in turn, boosts revenues of exports-oriented businesses. As far as India’s trade competitiveness is concerned, rupee’s depreciation is positive. The country had reported a record high trade deficit of $37.8 billion in November, as exports declined.

However, there's another side to the coin. Weakness in the domestic currency increases production cost for export businesses that use imported inputs. Examples of this are petroleum products, which constituted 11.52% of India's overall exports, as per November trade data. Higher crude oil prices, combined with a weaker rupee make imports more expensive, leading to higher prices of finished petroleum products. Hence, the end product’s value increases in the international market, subsequently reducing its competitiveness.

In other words, businesses like oil refineries, that import crude oil, are likely to be impacted by the weakness in the domestic currency.

A depreciating currency makes imports from international markets expensive, which weighs on the demand for imported goods and services. Since India is a net importer of goods, a weaker domestic currency may inflate the import bill. On the other hand, it encourages domestic productions as traders may start to look for cheaper alternatives in the country.

"With the trade deficit widening, allowing currency to weaken somewhat can be an automatic stabiliser, which can cool imports, even if it does not boost exports (given weaker global demand)," Nomura said in a note.

India’s import surged 27% year-on-year to $69.95 billion in November which took the merchandise trade deficit to a record high. This coincides with the 0.49% decline in the Indian unit against the US currency.

As a depreciated currency makes import costly, the prices of imported goods and services in the domestic markets also rise, which raises the risk higher inflation in the country.

A depreciation in a currency increases the foreign exchange reserve’s value. Moreover, trade competitiveness increases export revenue, which paves the way for more foreign fund inflows into the domestic markets. This gives a chance to regulators accumulate reserves.

Nevertheless, in times of a sharp depreciation, the Reserve Bank of India intervenes to sell foreign currency to protect the domestic unit, subsequently eroding the reserves.

India’s foreign exchange reserves declined $60.50 billion to $644.39 billion in the week ended on Dec. 20 from a record high of $704.89 billion. The reserves rose to a record high in the week ended on Sept. 27, according to data on Informist.

If a country has debts in foreign currency, repayments amount will increase due to a decline in the domestic unit’s value. However, the Rupee’s depreciation is not significant to make any substantial impact on India’s debt burden.

India has estimated that its external debt will likely to be at Rs. 15,952 crore in the current financial year compared to Rs 24,832 crore in 2023-24, according to data on Budget 2024-25 statement.

Theoretically, a central bank or a regulator can raise the benchmark interest rates to arrest decline in the domestic currency as it's one of the ways to give natural strength. However, it may not be applicable in the rupee's case due to other economic factors in India.

The Reserve Bank of India is expected to cut rates in 2025 in the backdrop of slowing growth and higher inflation. RBI retained the benchmark repo rate at 6.50% for eleventh time in a row in December. Most analysts expect the Indian central bank to enter a shallow rate-cut cycle.

"I don't think RBI will be able to do more than 50 basis points this year. The reason is currency depreciation pressure will be there. They will have to keep intervening," said Anitha Rangan, economist and director, Equirus Group. "Plus, there's geopolitical factor. More than 50 bps is difficult, but they will act in other ways. RBI always has other tools manage liquidity and rates other than policy action."