The Indian rupee recently breached the 86 mark against the US dollar, hitting a record low of 86.31. This sharp depreciation has left many wondering what caused the rupee to fall so significantly. Understanding the factors behind this change requires a closer look at both global and domestic economic dynamics. Let’s break down the primary reasons that have contributed to this situation.
1. The US Dollar Strengthens: Global Economic Influences
The strength of the US dollar is perhaps the most significant factor behind the rupee’s fall. The US dollar has been appreciating due to several key economic developments, particularly the release of strong economic data from the United States. On January 5, the US job market showed unexpected resilience, with Non-Farm Payroll (NFP) data showing a gain of 256,000 jobs, far surpassing the anticipated 160,000. Additionally, the unemployment rate dropped to 4.1%, which was another positive signal for the economy.
When such strong data is released, markets tend to expect that the US Federal Reserve (Fed) will be less aggressive in cutting interest rates. As a result, the US dollar becomes more attractive to investors seeking higher returns, pushing up its value against other currencies, including the Indian rupee.
What does this mean for the Indian rupee?
The appreciation of the US dollar typically leads to the depreciation of emerging market currencies like the rupee. As the dollar strengthens, it becomes more expensive to buy dollars with rupees, which puts downward pressure on the value of the rupee.
2. The Federal Reserve’s Approach: Impact on Global Currencies
Another crucial element contributing to the rupee’s fall is the stance of the US Federal Reserve. The Fed has been cautious about cutting interest rates too aggressively, as evidenced by its cautious tone in recent policy meetings. Following the strong economic data, the market now expects that the Fed will only cut interest rates by 25 basis points (bps) in 2025, rather than the more significant cuts initially anticipated.
Why does this matter?
When the US Federal Reserve keeps interest rates relatively high or only makes small cuts, it strengthens the US dollar. Investors are drawn to US assets because of the better returns they offer, making the dollar more valuable. For countries like India, which have large external debts and a dependence on foreign investment, this strengthens the US dollar at the expense of their local currency, such as the rupee.
3. Rising Crude Oil Prices: An Added Pressure on India
India is a net importer of crude oil, meaning it relies on imports to meet its oil demand. When crude oil prices rise, it increases the country’s import bill, which requires more dollars to pay for the imports. In turn, this higher demand for US dollars further weakens the rupee.
How do oil prices impact the rupee?
Increased crude oil prices mean India needs more foreign currency to purchase the same quantity of oil, which leads to a greater demand for dollars. As a result, the rupee depreciates because it is less in demand compared to the dollar. Recently, the price of Brent crude, the global oil benchmark, surged to USD 81.23 per barrel, placing additional pressure on the Indian currency.
4. Foreign Institutional Investor (FII) Outflows: Capital Flight from India
Another factor contributing to the rupee’s weakness is the continued outflow of capital from the Indian equity market. Foreign institutional investors (FIIs), who are major participants in India’s stock markets, have been pulling out their investments. In January 2025 alone, approximately $4.2 billion exited the Indian markets.
Why does this matter?
When foreign investors sell off their investments in Indian markets, they convert their rupees back into dollars, increasing the demand for dollars. This demand for the US currency further weakens the rupee. Additionally, capital outflows signal a lack of confidence in the domestic economy, further exerting downward pressure on the rupee.
5. Role of the Reserve Bank of India (RBI)
While global factors have largely contributed to the rupee’s fall, the Reserve Bank of India (RBI) also plays a role in influencing the currency’s movement. Forex dealers have noted that the RBI has allowed the rupee to depreciate in recent days. In fact, the rupee opened at a record low of 86.12 on January 8, 2025, and continued to slide.
Why would the RBI allow the rupee to depreciate?
The RBI may allow the rupee to weaken in a controlled manner to help correct imbalances in the domestic economy. A weaker rupee could make Indian exports more competitive on the global market, helping exporters by making their goods cheaper. Additionally, the RBI might want to avoid sharp volatility in the currency market, and a gradual depreciation can sometimes help achieve this.
6. Dollar Index and US Bond Yields: Further Indicators of US Dollar Strength
The strength of the US dollar is further reflected in the rise of the dollar index, which measures the dollar’s performance against a basket of six other major currencies. The dollar index has recently risen by 0.27%, indicating the continued strength of the greenback. Additionally, US 10-year bond yields rose to 4.71%, signaling investor confidence in the US economy and further boosting the dollar.
Why is this relevant to the rupee?
As US bond yields rise, foreign investors are more likely to move their capital into US assets, resulting in capital outflows from emerging markets like India. This contributes to the rupee’s depreciation, as the demand for US dollars increases in global markets.
7. The Outlook for the Rupee: What to Expect in the Coming Weeks
The outlook for the rupee in the short term remains uncertain. Analysts expect the rupee to trade within the range of 85.80–86.50 against the US dollar, with the potential for increased volatility. As global and domestic factors evolve, the rupee’s movement will be influenced by a variety of forces, including further US economic data, the Federal Reserve’s actions, and the trajectory of crude oil prices.
What’s next for the rupee?
If crude oil prices continue to rise, or if FIIs continue to pull out of Indian markets, the rupee could face more pressure. However, the Reserve Bank of India’s interventions and any potential policy changes from the US Federal Reserve could also impact the currency’s trajectory.
Also Read: India’s GDP Growth Hits a 4-Year Low of 6.4%
Disclaimer: This article aims to provide an objective analysis based on publicly available information. The views expressed here are for informational purposes only.
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