Context: The exchange rate has changed from less than ₹4 a dollar in 1947 to more than ₹85/dollar in 2025. Given the higher inflation target in India than in the US, we need to accept depreciation of the rupee. However, we can, going forward, slow down the rate of depreciation.
Relevance of the Topic: Prelims: Relationship b/w exchange rate, inflation and exports, Rupee Depreciation- Causes.
What is Currency Depreciation?
- Currency depreciation is a fall in the value of a currency in a floating exchange rate system.
- It means that the rupee is now weaker than what it used to be earlier.
- Rupee depreciation means that the rupee has become less valuable with respect to the dollar.
- For instance, $1 used to equal Rs. 4 in 1947, now $1 is equal to Rs. 85.
- This implies that the rupee has depreciated relative to the dollar i.e., it takes more rupees to purchase a dollar.
Causes of Rupee Depreciation:
- High Inflation Target: Currently, RBI has an inflation target of 4 per cent.
- Persistent inflation weakens the value of rupee, causing its depreciation and decreasing its purchasing power.
- Food Price Inflation: RBI has found it difficult to meet the accepted inflation target rate, mostly due to a big rise in food prices.
- Competitiveness in Exports: A decline in India's competitiveness in production and exports weakens the rupee.
- Factors such as high production costs, regulatory hurdles, and inadequate infrastructure contribute to reduced export performance.
How to control Rupee Depreciation?
- Reducing inflation target: Shift from 4 per cent inflation target to 3 per cent target next year when inflation targeting will be up for a review.
- A reduced inflation target is also desirable for the less well-off. So, there is a need to amend the mandate under inflation targeting.
- This shift requires coordinated efforts by the Reserve Bank of India (RBI), the Ministry of Finance (MoF), and Parliament.
- Controlling Money Supply: RBI must regulate the issuance of money to control inflation in the long term.
- While this may reduce the RBI's dividend to the Ministry of Finance, alternative revenue sources or expenditure cuts can compensate for the shortfall.
- Reducing Food Price Inflation:
- Framing a policy of more free trade in food.
- A calibrated policy of procurement, reserves, timely distribution, and a countercyclical tax-subsidy scheme can also help.
- This necessitates collaboration among the Ministry of Agriculture, Ministry of Commerce and Industry, and MoF.
- Enhancing Export Competitiveness:
- Improving the competitiveness of Indian goods in foreign markets through steps like simplifying regulatory frameworks, removing entry barriers, etc.
- Facilitating Ease of Doing Business.
- Role of RBI:
- RBI should intervene in the currency market, but do so only when it is absolutely necessary.
- It is also consistent with flexible inflation targeting.
In conclusion, at least for now it is advisable to accept the long-term fall in the value of the rupee vis-a-vis the dollar but we can move to a slower rate of depreciation. This requires some serious work by the central bank and other public authorities but it is doable.