Rupee drops for second straight month but RBI support curbs losses

The Indian Rupee's recent depreciation, culminating in a drop past the 91-per-dollar mark in December, and the subsequent intervention by the Reserve Bank of India (RBI), is a critical event for understanding India's economic stability and its integration into the global financial system. This episode highlights the constant interplay between domestic economic fundamentals, global financial flows, and the proactive role of India's central bank.

**Background Context and What Happened:**

Currency depreciation occurs when a country's currency loses value relative to another currency. For the Indian Rupee, its value against the US Dollar is a key indicator of economic health. Several factors typically contribute to such a decline: a widening current account deficit (CAD), capital outflows (when foreign investors pull money out of the Indian market), rising global interest rates (making dollar-denominated assets more attractive), and geopolitical uncertainties. In the period leading up to December, global factors such as aggressive interest rate hikes by the US Federal Reserve, coupled with persistent energy price volatility and a robust dollar index, exerted significant pressure on emerging market currencies, including the Rupee. The Rupee had already been under pressure, and its breach of the 91-per-dollar level for the first time indicated increased market stress, signaling a prolonged period of weakness.

**Key Stakeholders Involved:**

1. **Reserve Bank of India (RBI):** As India's central bank and monetary authority, the RBI is the primary custodian of the country's foreign exchange reserves. Its mandate, outlined in the Reserve Bank of India Act, 1934, includes maintaining monetary stability, ensuring the smooth functioning of financial markets, and managing the country's external sector. The RBI intervenes in the forex market by selling dollars (and buying rupees) when the rupee depreciates sharply, or buying dollars (and selling rupees) when it appreciates too rapidly. This intervention aims to smooth out volatility and prevent disorderly movements, not to target a specific exchange rate.

2. **Ministry of Finance, Government of India:** While the RBI manages monetary policy, the Ministry of Finance is responsible for fiscal policy and broader economic management. A depreciating rupee impacts government finances, particularly external debt servicing and the cost of imported goods, influencing inflation and the overall fiscal deficit.

3. **Exporters and Importers:** Exporters generally benefit from a depreciating rupee as their goods become cheaper for foreign buyers, boosting competitiveness. Importers, however, face higher costs for imported raw materials, machinery, and finished goods, potentially leading to higher domestic prices (imported inflation).

4. **Foreign Institutional Investors (FIIs) / Foreign Portfolio Investors (FPIs):** Their investment decisions in Indian equity and debt markets significantly influence capital flows. Outflows by FIIs often put downward pressure on the rupee, while inflows strengthen it.

5. **Indian Public/Consumers:** A weaker rupee can lead to higher prices for imported goods like crude oil, electronics, and even certain food items, impacting household budgets and contributing to inflation.

**Why This Matters for India:**

This event is significant for several reasons. Firstly, a rapidly depreciating rupee can fuel **inflation**, especially in a country heavily reliant on crude oil imports. Higher import bills translate to higher domestic fuel prices and, subsequently, higher transportation costs, impacting the entire supply chain. Secondly, it affects India's **current account deficit (CAD)**. A weaker rupee makes imports more expensive and exports cheaper, but given India's structural import dependence (especially for energy), the net effect can be a widening CAD, which then needs to be financed by capital inflows. Thirdly, it impacts **foreign investment confidence**. Excessive volatility or a sustained depreciation can deter foreign investors, affecting capital formation and economic growth. Finally, it increases the **cost of servicing external debt** for both the government and corporations.

**Historical Context and Future Implications:**

India operates under a 'managed float' exchange rate system, meaning the rupee's value is largely market-determined, but the RBI intervenes to curb excessive volatility. This approach has been in place since the early 1990s. India has witnessed significant rupee depreciation events in the past, such as during the 2008 global financial crisis or the 2013 'taper tantrum' when the US Federal Reserve signaled a reduction in its quantitative easing. In each instance, the RBI employed a combination of market interventions, monetary policy adjustments (like raising interest rates), and capital control measures to stabilize the currency. The current situation suggests that the RBI will continue its vigilance, using its substantial foreign exchange reserves to manage volatility. Future implications include the RBI maintaining a watchful stance, potentially adjusting interest rates or liquidity to counter inflationary pressures and support the rupee. The government's fiscal management and efforts to boost exports will also play a crucial role in strengthening the rupee's fundamentals. Global factors, particularly the trajectory of US interest rates and geopolitical stability, will remain dominant external influences.

**Related Constitutional Articles, Acts, or Policies:**

While there are no direct constitutional articles governing currency exchange rates, the **Reserve Bank of India Act, 1934**, establishes the RBI's role and powers, including its authority over monetary policy and foreign exchange management. The **Foreign Exchange Management Act (FEMA), 1999**, replaced FERA (Foreign Exchange Regulation Act, 1973), liberalizing foreign exchange transactions and facilitating external trade and payments. The **Monetary Policy Framework Agreement** between the Government of India and the RBI (signed in 2015, formalized in 2016) mandates the RBI to primarily target inflation, with exchange rate stability being a secondary objective often managed to support the primary goal. These acts and policies provide the legal and operational framework for the RBI's interventions and the overall management of India's external sector. The broader economic policies, including trade and fiscal measures, are formulated under the legislative powers derived from various articles of the Constitution, such as Article 246 (distribution of legislative powers) and the Seventh Schedule (Union List items like 'Foreign exchange' and 'Public debt').