Nature of the Devaluation:
- The Indian rupee experienced sharp devaluation, marking a departure from the relative stability maintained over the past two years.
- Driven by increased capital outflows, rising import costs, and higher crude oil prices.
Relevance : GS 3(Economy )
Exchange Rate Policies:
- India predominantly follows a managed-floating exchange rate regime.
- The Reserve Bank of India (RBI) has balanced devaluation with adjustments to foreign exchange reserves, especially during periods of excess demand for foreign currency.
- Post-COVID, the RBI temporarily adopted a strategy akin to a fixed exchange rate regime but reverted to a managed-float approach recently.
Implications of Depreciation:
- Positive Impact: Can boost net exports if domestic goods become cheaper relative to foreign goods, provided domestic inflation remains controlled.
- Negative Impact: Higher import costs can increase the variable costs of firms, leading to inflation, squeezing real incomes, and diminishing purchasing power.
Structural Challenges:
- Divergence between nominal effective exchange rate (NEER) and real effective exchange rate (REER) since the mid-2010s.
- Despite rupee devaluation, rising domestic prices have appreciated the real exchange rate, eroding export competitiveness.
- Increased markups by non-financial firms have contributed to domestic inflation.
Policy Dilemmas:
- The RBI’s inconsistent policy responses, including frequent shifts without transparent communication, have raised questions about India’s exchange rate strategy.
- The devaluation highlights the need for a robust framework to address both short-term adjustments and long-term objectives like export competitiveness and inflation control.
Reflection:
The Indian economy faces a dual challenge: managing inflationary pressures due to rupee depreciation while ensuring that real exchange rate movements do not hinder export recovery. A well-communicated and adaptive exchange rate policy will be crucial to navigating these economic complexities.
