Context:
The Indian rupee has witnessed a broad-based depreciation against major global currencies over the past year. According to RBI data, this shift—accompanied by a decline in the Real Effective Exchange Rate (REER)—has moved the rupee from an overvalued to an undervalued zone, potentially improving export competitiveness and helping India manage its record trade deficit.
Key Highlights:
Extent of Rupee Depreciation
- Against US Dollar: –5.6%
- Against Euro: –9.4%
- Against British Pound: –14.3%
- Indicates a broad and not isolated weakening
REER Movement
- REER fell from 108.1 (Nov 2024) to 97.5 (Oct 2025)
- Signals a shift from overvaluation to undervaluation
- Enhances price competitiveness of Indian exports
Trade and Macroeconomic Context
- Merchandise trade deficit: $41.7 billion (October)
- Global environment marked by deflationary pressures
- Rising risk of cheap imports, particularly from China
RBI’s Exchange Rate Stance
- Shift towards a more flexible exchange rate policy
- Allows the rupee to float in a calibrated manner
- Intervenes mainly to prevent excessive volatility, not to target a level
Detailed Insights:
Why Depreciation Is Viewed Positively
- An undervalued rupee:
- Makes Indian exports cheaper and more competitive
- Acts as a shock absorber against global demand slowdown
- Discourages excessive imports by raising their domestic cost
China Factor and Global Pressures
- China’s potential export surge due to deflationary conditions
- Weaker rupee helps mitigate import penetration from low-cost economies
Policy Shift by RBI
- Earlier approach relied on:
- Overvalued exchange rates
- Trade policy tools like tariffs and export bans
- Current approach:
- Greater reliance on exchange rate flexibility
- Better alignment with macroeconomic fundamentals
Inflation and External Balance Considerations
- Easing domestic inflation provides space for currency flexibility
- Helps correct current account and trade imbalances
- Supports long-term competitiveness rather than short-term price stability alone
Relevant Prelims Points:
- Real Effective Exchange Rate (REER):
- Weighted average of a currency against a basket of trading partner currencies
- Adjusted for inflation differentials
- Current Account Deficit (CAD):
- Occurs when imports exceed exports of goods, services, and transfers
- Issue & Causes:
- Global deflationary trends
- Shifts in capital flows and trade dynamics
- Impact & Benefits:
- Boosts exports
- Discourages non-essential imports
- Enhances external sector resilience
- Challenges:
- Imported inflation risk
- Higher cost of external debt servicing
Relevant Mains Points:
- Economic Rationale:
- Exchange rate as a macro adjustment tool
- Balance between competitiveness and price stability
- Governance & Policy Dimension:
- RBI’s role in managing volatility while allowing market signals
- Keywords & Concepts:
- Exchange rate flexibility, trade competitiveness, external balance
- Way Forward:
- Maintain calibrated flexibility in exchange rate management
- Complement depreciation with export facilitation measures
- Monitor inflation and capital flow risks
- Structural reforms to enhance non-price competitiveness of exports
UPSC Relevance (GS-wise):
- GS 3: Indian Economy, External Sector, Monetary Policy