Why Rupee Fell to Record Low

January 6, 2025

In December 2024, the Indian rupee reached a record low of 85.81 against the U.S. dollar. This decline marked a 3% depreciation over the year, continuing a long-term trend. Various factors contribute to currency depreciation, primarily involving supply and demand dynamics in the foreign exchange market.

Currency Value Determinants

The value of a currency is influenced by its demand and supply in the foreign exchange market. When demand for a currency decreases, its value falls. Conversely, if demand increases, the currency appreciates. This mechanism operates similarly to product pricing in conventional markets, where supply and demand dictate costs.

Role of Central Banks

Central banks play a very important role in determining currency supply through their monetary policies. A looser monetary policy increases the currency supply, potentially leading to depreciation. In contrast, tighter monetary policies can enhance currency value by reducing supply and increasing demand.

Foreign Demand for Goods and Assets

The demand for a currency is also influenced by foreign interest in a country’s goods and assets. High foreign demand necessitates purchasing local currency, thereby increasing its value. Conversely, a decline in foreign demand results in decreased currency value.

Factors Behind the Rupee’s Decline

The recent depreciation of the rupee has largely been attributed to foreign investors withdrawing from India. This trend has been exacerbated by global monetary policy shifts and high inflation rates in India compared to the U.S. The Reserve Bank of India’s (RBI) looser monetary policy has made the rupee less attractive, contributing to its decline.

Impact of Inflation and Imports

India’s high inflation rates, particularly in the wake of the COVID-19 pandemic, have pressured the rupee. The country’s reliance on high-value imports, like crude oil and gold, increases demand for the dollar, further weakening the rupee. Additionally, the inability to boost exports has hindered rupee demand.

RBI’s Intervention Strategies

To mitigate rupee depreciation, the RBI has intervened by using its dollar reserves. This strategy aims to increase dollar supply in the market, supporting the rupee’s value. However, this intervention has led to a decrease in foreign exchange reserves, which fell to $640 billion by late December 2024.

The rupee’s low of 85.81 was a historic benchmark.
The RBI’s reserves dropped from $700 billion in September 2024.
Foreign investment shifts were prompted by global monetary policy changes.
High inflation in India contrasts sharply with the U.S. economy.
The RBI aims for gradual rupee depreciation to avoid economic disruption.

Future Prospects for the Rupee

Analysts suggest that without RBI intervention, the rupee’s depreciation could have been more severe. The ongoing economic conditions and global market shifts will continue to influence the rupee’s performance against the dollar.

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