On February 3, the Indian rupee plunging past the 87-mark against the dollar signalled a growing vulnerability in the currency, spurred by both global and domestic factors. For the first time, the rupee breached this crucial threshold, driven by escalating trade tensions and domestic fiscal challenges. This sharp decline is not merely a momentary blip, but a symptom of deeper issues that need urgent attention from policymakers and market participants alike.
At the heart of the rupee’s struggles is the ongoing trade war, particularly the new tariffs imposed by the United States. President Donald Trump’s 25% levy on imports from Mexico and Canada, along with the 10% tariff on Chinese goods, has triggered retaliatory actions from these nations, exacerbating global market uncertainty.
While these tariffs are designed to protect American interests, they have rattled global supply chains and currency markets, putting pressure on emerging market currencies like the rupee. The offshore Chinese yuan’s recent drop has compounded the rupee’s woes, illustrating the broader weakness in Asian currencies as investors flock to safer assets, particularly the U.S. dollar.
At a broader level, the rupee’s decline is further compounded by the global strengthening of the dollar, bolstered by rising U.S. Treasury yields. The impact is felt across the board, as countries with large current account deficits, like India, are particularly susceptible to such fluctuations.
Flight of foreign funds
For India, which has seen foreign portfolio investors (FPIs) sell equities and shift to the safety of dollars, the currency’s vulnerability is exacerbated. This flight to the dollar is contributing to a liquidity squeeze in the Indian banking system, leaving the Reserve Bank of India (RBI) to intervene with a slew of measures aimed at maintaining stability. The RBI is set to announce the monetary policy on February 7.
The RBI’s actions, such as injecting liquidity through Open Market Operations (OMOs) and conducting Variable Rate Repo (VRR) auctions, are critical in easing the liquidity crunch. However, the fact is that these efforts cannot mask the underlying challenges. The systemic liquidity deficit, currently hovering around Rs 3.13 lakh crore, is a stark reminder that India’s financial system is under strain. The RBI’s interventions, though necessary, are symptomatic of a deeper issue—the need for more robust structural reforms to ensure long-term currency stability.
On the domestic front, India’s fiscal policy is also adding to the pressure. The government’s decision to raise its borrowing targets for the next fiscal year, while promising fiscal consolidation, has left market participants uneasy. Despite a lower fiscal deficit target for FY26, the increase in borrowing to Rs 14.82 lakh crore signals that the government may struggle to balance growth with fiscal prudence. This concern is reflected in the bond markets, where traders expect continued volatility in yields, especially with the RBI poised to cut interest rates to support growth.
What next?
Probably, what we are witnessing is not just a short-term dip in the rupee, but a broader reflection of India’s macroeconomic challenges. As global trade tensions persist and the domestic fiscal landscape remains volatile, the rupee’s trajectory will largely depend on the RBI’s ability to navigate these choppy waters. The upcoming monetary policy decision, scheduled for February 7, will be closely watched. A rate cut is expected, but its effectiveness in shielding the rupee from further depreciation remains uncertain.
To cut a long story short, the rupee’s fall below 87 against the dollar is a wake-up call. While the RBI’s interventions are necessary, they cannot substitute for deeper structural reforms that address the root causes of the currency’s weakness. India must focus on improving its export competitiveness, diversifying foreign investment sources, and ensuring that fiscal policies align with long-term stability rather than short-term fixes.
Till then, the rupee’s vulnerability is likely to persist.