The dollar’s strengthening is basically a global problem, arising from the US President-elect Donald Trump’s threats to effect across-the-board import tariffs — even more on goods from China — and mass deportations of illegal immigrants.
Dec 23, 2024 07:35 IST First published on: Dec 23, 2024 at 07:35 IST
Last week, the rupee breached the psychological 85-to-the-dollar mark, sliding to a low of 85.11 and closing at 85.02. In itself, that shouldn’t be cause for worry. The current fall is more about a strengthening US dollar than a weakening Indian rupee. Since September 25, the dollar index, which measures the greenback’s value relative to a basket of major currencies, has risen from a low of 99.8 to a high of 108.3. During this time, the rupee’s reference rate, as per the Reserve Bank of India (RBI), has depreciated vis-à-vis the dollar (from 83.55 to 85.09), but also appreciated against the euro (93.49 to 88.17), pound (111.98 to 106.29) and yen (0.58 to 0.54). Also, one mustn’t ignore the extended period, from roughly late-September 2022 to mid-October 2024, when the rupee traded within an 81-84 range. It’s the decline thereafter, breaking through 84 on October 11 and 85 on December 19, that is striking.
The dollar’s strengthening is basically a global problem, arising from the US President-elect Donald Trump’s threats to effect across-the-board import tariffs — even more on goods from China — and mass deportations of illegal immigrants. These, together with deficit-financed income tax cuts, are expected to drive up inflation and, in turn, made the US Federal Reserve cautious; it is now suggesting only two interest rate cuts in 2025, versus the four that was projected in September. The prospect of the Fed keeping monetary policy tight has led to 10-year US government bond yields soaring since September 25, from below 3.8 to over 4.5 per cent, along with the dollar index. How much and how long this will continue remains to be seen. An overvalued dollar and high interest rates could hurt the US economy by rendering exports uncompetitive and depressing business investment. The resultant slowdown would, then, force the Fed to reduce rates.
What should the government and RBI do? First, they must not look at just the dollar. India’s trade competitiveness depends on the rupee’s effective exchange rate with not only the dollar, but also with other global currencies. If they are weakening more against the dollar, there’s no point shoring up the rupee’s value relative to the greenback alone. Second, don’t use interest rates as a tool to defend the rupee. The RBI’s repo rate should be lowered or left unchanged based on the trajectory of consumer price index inflation, not the rupee’s exchange rate. Third, in times such as these, ensuring macroeconomic stability matters. The coming months may see more capital outflows, which can, to some extent, be offset through sale of dollars from the RBI’s reserves. The key, though, lies in containing fiscal and current account deficits, adhering to inflation targets, and demonstrating that India’s growth story is still intact.
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