The rupee’s sharp depreciation against the dollar, inching closer to the 80 level, is causing considerable consternation and policymakers are now embarking on fiscal actions to buttress the currency. The recent hike in import duty on gold is, for example, aimed at curbing the rising gold imports, thus controlling the current account deficit and supporting the rupee. The Reserve Bank of India (RBI) however has its work cut out because most of the factors which are currently responsible for the rupee’s depreciation, are external. The Indian currency had been quite safe until the third quarter of 2021, with copious FPI flows and improvement in trade balance lending it strength. The RBI had intervened aggressively in the forex market in 2020 and 2021 to keep the rupee from appreciating too much and this had led to forex reserves increasing to $640 billion by last September. But with the US Federal Reserve announcing its schedule for tapering the pandemic-related stimulus and beginning to increase interest rate towards the end of last year, FPIs turned net sellers in Indian markets and the rupee began losing ground. The Russia-Ukraine war and the resulting surge in commodity inflation resulted in funds flowing towards safe havens such as the dollar, applying further pressure on the rupee.

There is little that can be done to control the rapid appreciation in the dollar and the elevated crude oil prices. The rupee is particularly vulnerable in phases when crude oil surges due to the country’s near-total dependence on imports for meeting domestic fuel requirements. But raising domestic production of crude oil, improving energy security and increasing usage of renewable energy can be done only over the longer term. As a short-term fix, the RBI had been actively intervening in the foreign exchange market over the last few months to prevent rapid depreciation of the Indian currency. But this is resulting in depleting the foreign exchange reserve – which is down 7 per cent since last October. Continued erosion of reserves is not an ideal situation since import cover as well as the ability to service external debt is impacted. The sharp interest rate hikes by the RBI have not helped much since many other emerging economies have raised rates far more aggressively compared with India. At best, RBI’s rate actions have ensured that there will not be a run on the rupee as it happened during the “taper tantrum” episode in 2013. Actions to hike duties to curb imports are also likely to have limited impact. As commodity price inflation remains elevated and core inflation too increases due to unlocking of economies, US treasury yields are expected to remain strong, attracting foreign funds into dollar-denominated securities. This is going to impact all emerging market currencies including the rupee.

That said, it needs to be noted that the rupee has been among the better performing currencies in Asian basket with year-to-date depreciation of 4.6 per cent against the dollar. Other currencies such as the Yuan, Thai Baht and South Korean Won have depreciated over 5 per cent this year. Instead of worrying over exchange rate levels, the central bank should stick to its oft stated policy of only ensuring that the movement of the currency is orderly and not volatile. Given the highly uncertain external environment, unilateral policy actions in India are likely to have only limited impact.