The Stability of the Indian Rupee: A Closer Look

The recent depreciation of the Indian rupee has drawn significant attention and commentary. Despite some perceptions, it’s important to understand that the rupee hasn't overly depreciated compared to many other currencies. The Reserve Bank of India (RBI) continues to apply a successful policy that has stood the test of time since the economic liberalisation of the 1990s. This policy focuses on intervention to manage excess volatility in the exchange rate.

Understanding Exchange Rate Management

One key aspect of the RBI's approach is that while the fundamental exchange rate regime has not changed, its application has evolved. Since liberalisation, the exchange rates have been largely determined by market forces, albeit with RBI stepping in where excessive volatility threatens stability. The levels of intervention have varied depending on policy goals and external conditions, especially when facing significant capital outflows.

For instance, during the initial decade of liberalisation, the nominal depreciation of the rupee acted as a compensation for heightened inflation in the country, ensuring that the real effective exchange rate (REER) remained competitive. However, as the currency markets have matured, fluctuations have become more pronounced, particularly since the 2000s.

The Impact of Intervention and Global Conditions

Historically, moments of sharp volatility, such as after the global financial crisis, have prompted the RBI to intervene directly to stabilise the rupee. There was a phase where the RBI believed that market forces had become too strong for intervention to be effective, leading to a significant drop in the rupee's value. However, the subsequent successful stabilization efforts reinforced the importance of timely interventions. Maintaining a balance between intervention and market forces has become essential.

Capital flows into and out of India often respond to global market conditions. For example, during periods of heightened risk aversion globally, there might be significant foreign portfolio investment (FPI) outflows. However, these outflows tend to later be countered by inflows, allowing the RBI to moderate the depreciation of the rupee through reserve sales. Such strategic actions help keep the rupee relatively stable against market shocks.

Current Trends and Future Expectations

As of today, the rupee's nominal depreciation has been moderate, especially when compared to previous years. The nominal value against the dollar moved from 71.5 in February 2020 to about 84.06 by October 2024, indicating that while depreciation has occurred, it has not been as drastic as in previous crisis years. This is particularly relevant in light of global strength in the US dollar, which may shift after the upcoming political changes in the US.

Furthermore, it’s crucial to note that low volatility in the currency acts to reduce risk premiums in the market, which assists in stabilising investments. A flexible but managed exchange rate regime helps mitigate extreme fluctuations, providing a buffer against the shocks often faced in emerging markets like India.

The Importance of Export Competitiveness

Exporters are keenly impacted by changes in the exchange rate. Although immediate depreciation can raise the costs of importing commodities, exporters need to maintain competitiveness in international markets. To ensure that the trade deficit remains manageable, a balanced real effective exchange rate is essential. The RBI aims to keep this rate around the threshold of 100, allowing for necessary interventions based on prevailing market and inflation conditions.

To sum up, while the rupee is not entirely free from fluctuations, its volatility is significantly lower compared to many other emerging markets, thanks to the RBI’s continual interventions and policies. This strategic approach minimizes the risk of currency overshooting and presents a stable environment for both domestic and international investments.

In conclusion, the Indian rupee's ongoing management reflects a balance aimed at fostering stability while catering to the diverse interests of economic stakeholders. This well-tested policy framework of the RBI remains a pivotal component in safeguarding the rupee against excessive volatility as it navigates the complexities of global financial landscapes.

rupee, RBI, intervention