Indian newspapers have been full of stories about the fall of the rupee vis-àvis the US dollar in the past few days. On 27 November 2024, the value of the dollar was Rs 84.55; by 29 December, it had risen to Rs 85.50. On 13 January 2025, it hit 86.50.
The crash occurred despite a running down of foreign exchange reserves by the Reserve Bank of India to stabilise the rupee. The reserves, which amounted to $657.89 billion on 22 November had come down to $644.39 by 20 December, and yet the fall of the rupee could not be prevented. The downward drift of the rupee has been a persistent phenomenon.
For a very long time during the dirigiste period, the price of the rupee vis-à-vis the dollar was fixed (with an occasional government determined devaluation) and sustained by foreign exchange control in the economy.
In 1991, immediately after the lifting of such controls, when the rupee was first floated, the exchange rate was Rs 22.74 to the dollar; by 2014, when Narendra Modi came to power the rate had become Rs 62.33, and now it has crossed Rs 86.50.
The primary cause
This persistent long-term decline of the rupee is not because the rate of inflation in India is higher than in the US. It certainly is higher but that is not the primary cause of the rupee’s depreciation. On the contrary, an important reason for the rate of inflation in India being persistently higher than in the United States is the depreciation of the rupee, which raises import costs of a whole range of essential inputs such as oil.
These higher costs get passed on as higher prices. Whatever might have been the primary cause of the rupee’s depreciation, once inflation does get stimulated by it, it certainly impacts the exchange rate of the rupee.
Anticipating a further exchange rate depreciation because of inflation, speculators depreciate it further. The primary cause of the rupee’s depreciation—hold your breath—is the preference of the Indian rich to hold their wealth in the form of US dollars rather than Indian rupees.
This gives rise to a persistent shift from rupees to dollars that causes the rupee’s depreciation. The persistent depreciation of the exchange rate vis-à-vis the dollar is not confined to India; it characterises most Third World countries.
And it is one very important reason why the exchange rate of the rupee should never be left floating but should rather be pegged against the dollar and sustained by capital controls and foreign exchange controls to the extent necessary, as was the case during the dirigiste period. This secular fall of the rupee, however, occurs unevenly: rapidly in some periods and less rapidly in others.
The question, therefore, arises: why has there been a sudden fall in the value of the rupee in the past few weeks? Newspapers have discussed this, with commentators adducing factors such as the current inflation rate in India being more rapid than in the US and the current widening of India’s trade deficit.
Quite apart from India-specific factors, one factor that has not received much attention is that the strengthening of the dollar is not just against the rupee, but visà-vis almost every major currency of the world.
US protectionism
The dollar has not been as strong as it is today at any other time over the past decade: the Bloomberg Dollar Spot Index has risen by 7 per cent this year, which makes it higher (in absolute terms) than in any other year since 2015. This appears intriguing at first glance, with US President Donald Trump having announced a proposed hike in tariffs.
Almost every day, we hear sermons from various international organisations, ranging from the IMF (International Monetary Fund) to the World Bank to the World Trade Organisation (WTO), lauding the virtues of free trade, which should categorise Trump’s coming policy as retrogressive.
Since the market is supposed to ‘know best’, shouldn’t the market be losing some faith in the future of the US? Shouldn’t we be witnessing some capital flight from there, lowering the value of the dollar? Instead, we find the exact opposite happening. How can we explain this apparently puzzling phenomenon?
The simple answer is: the sermons about the virtues of free trade are for the ears of gullible or pliable Third World politicians. The market does not take them seriously. Most market observers list US protectionism as a factor underlying the strengthening of the dollar.
It is obvious that protectionism in the US will increase aggregate demand in that country—and hence output and employment—by shutting out a chunk of those imports that had displaced domestic production.
While improving US employment at the expense of the rest of the capitalist world, it will also improve the trade balance of the US; in fact, it would improve aggregate demand in the US precisely by improving its trade balance.
In short, through its protectionist measures, the US would improve both its balance of payments position, as well as its employment and output. This is the reason the market’s assessment of the US economy has improved rather than deteriorated, which is the very opposite of what free trade advocates would have us believe.
This improved assessment translates into greater confidence in the dollar, compared with other major currencies, and hence into an appreciation in its exchange rate.
This is because the international prices of a number of commodities, especially critical inputs like oil, are fixed in dollar terms. An appreciation of the dollar would therefore have the effect of raising prices in the other currencies and impart an inflation push to other economies.
Impact on the Third World and the working class
Workers in the rest of the world, therefore, would suffer a fall in their living standards for two quite distinct reasons. One, a fall in employment because of the loss of the American market owing to American protectionism.
Two, the rise in inflation rate because of the cost-push imparted by the depreciation of their currencies vis-àvis the dollar. If the governments in these countries attempt to control such cost-push inflation by pursuing ‘austerity’ measures that increase unemployment and weaken the workers’ bargaining strength, then that will be yet another route toward workers’ impoverishment.
In the case of externally-indebted Third World countries, in addition to unemployment and inflation through the above-mentioned routes, there is an additional way in which the burden on the working people will rise—through the increase in the local currency value of their external debt which is typically incurred in US dollars. The burden of debt-servicing will increase and this burden will necessarily fall on the working people.
-PRABHAT PATNAIK is Professor Emeritus, Centre for Economic Studies and Planning, Jawaharlal Nehru University
