The rupee’s dilemma: Pride vs practicality

In India, the rupee has always been more than a currency. Its exchange rate is treated as a symbol of national pride – a “strong rupee” equated with stability, a “falling rupee” with weakness. Importers and stock market operators cheer a strong rupee because it keeps costs predictable. Policymakers, too, equate appreciation with credibility. However, global lessons can be instructive. A strong currency has its own problems. Japan’s forced appreciation following the 1980s Plaza Accord eroded its export competitiveness and fueled asset bubbles, which ultimately caused long periods of growth stagnation. A large part of the domestic problems underlying the US tariff wars is because the strong dollar has eroded its non-high-tech manufacturing competitiveness and employment-creating potential, while China’s deliberate undervaluation of the yuan continues to power its export-dependent boom.

However, our policy reflexes have their own deep roots: the traumatic 36.5% devaluation of 1966, the associated domestic inflation, and the consequential electoral losses left a scar that still shapes policy instincts. Since then, the declared policy has been to avoid exchange rate rigidities to avoid headline-making exchange rate shocks. Yet these recur. The causative factors need discussion.

One important aspect is that, given our high import dependence on several mass consumption items, such as fuel, edible oils, and fertilisers, policymakers lean towards defending the currency, wary of the inflationary consequences of visible depreciation even when fundamentals demand adjustment. These instincts, in combination, have produced cycles of defence followed by collapse, as fundamentals always, eventually, reassert themselves; so when the correction comes, it is abrupt.

The 1991 crisis was an important turning point. Two quick devaluations pushed the rupee near Rs 26 per dollar. Extensive governance reform, resulting in economic liberalisation, and financial market reforms were carried out. Longstanding ministerial oversight was replaced by the creation of well-staffed, adequately empowered, and independent regulators. These initiatives, over time, created a more efficient and responsive marketplace. The rise of the IT sector in global economies created new avenues of growth. In the decades that followed, service exports and capital inflows cushioned the external account, though the currency weakened steadily.

Furthermore, in support of the policy to avoid sudden exchange rate shocks, the Reserve Bank of India has, since the early 1990s, regularly been publishing Real Effective Exchange Rate (REER) tables to signal whether the rupee is over- or undervalued. However, REER is diagnostic, not preventive. It shows whether or not a currency is misaligned and, further, has an unspoken assumption of a status quo in the external environment. External shocks such as US Fed policy changes, oil crises, etc., can overwhelm based on their relevance to a particular economy. The 2012 and 2026 challenges are cases in point.

However, both of these latter crises have primarily occurred because manufacturing never achieved adequate depth or competitiveness, leaving India perennially exposed to current account deficits, mostly compensated for by capital market surpluses. This is happening because, when the 1991 liberalisation reforms were being carried out, reforms in the real economy were quietly deferred. Entrepreneurs have understood this reality. Even with schemes like the Production Linked Incentive (PLI), many hesitate to commit serious capital to factories. Cheap imports of components and machinery, thin margins, and weak global competitiveness make industry a tough bet compared to real estate, finance, or consumer ventures.

Established business houses reflect this shift, deepening investments in services and retail, while limiting manufacturing mostly to final-stage assembly of imported components and, often, sub-assemblies. This persistent lack of export-competitive manufacturing is the core vulnerability. Services exports have grown impressively, but without a strong industrial base, the rupee lacks resilience. That weakness magnifies the impact of external shocks – whether US Fed policy shifts, oil price spikes, or sudden capital outflows – turning what might have been manageable adjustments into sharp currency falls.

In recent weeks, the RBI has been in a firefighting mode. As the rupee slid toward Rs 95 to the dollar, it tightened rules on currency derivatives to choke speculation, only to ease them later to restore hedging flexibility. At the same time, it stepped into the spot market, selling dollars to slow the fall, while holding policy rates steady to signal calm. These moves can calm nerves in the short run, but they don’t change the underlying picture.

What India needs is not just crisis management, but deeper reform. Unless we strengthen governance in the real economy – by replacing ministerial oversight with autonomous, well-staffed regulators, devolving more economic authority to local institutions, and creating a framework that rewards productivity – the rupee will remain vulnerable. The other path is to send clearer policy signals that make technology-driven manufacturing more attractive to entrepreneurs. Only then will the currency rest on a stronger foundation, backed by competitiveness rather than constant defence.

(The writer is the former chairman of the Export Import Bank of India is a banker with a theory of everything.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.