India’s disinflation progress could derail amid sharp rupee depreciation

rupee-inflation

India’s disinflationary trajectory is likely to be derailed due to a sharp depreciation of the local currency against the US dollar in the last few months, experts said.

This is because a depreciating rupee increases the cost of imports, leading to imported inflation, they said.

Aditi Gupta, Economist at Bank of Baroda, said sectors heavily dependent on imported raw materials are likely to witness escalation in costs due to higher input prices, impacting margins. This can also translate into higher prices for consumers, which will put a strain on spending and consumption.

India’s retail inflation has been on the downward path for the last few months due to easing food inflation. India’s CPI inflation declined to a four-month low of 5.22 percent in December as compared to 5.48 percent in the previous month, as food prices provided some reprieve.

Despite the relief, experts believe that an increase in crude oil prices will have an impact on inflation in the coming months.

“India is heavily dependent on imports for its energy and some of the food items, which will directly or indirectly impact household budgets. The surging crude oil price and weaker rupee is a bad combination for India,” Dilip Parmar, a foreign exchange analyst at HDFC Securities, said.

Experts further said the depreciating rupee will have an impact on some segments which are part of the CPI index such as edible oils and pulses within food, while commodities like crude oil, gold, metals and core inflation will be most affected.

Further, a sharp depreciation in the domestic currency in the past couple of months will also lead to higher dollar hedging costs for Indian companies, making offshore borrowings an expensive affair. This will have an impact on their margins and dent profitability.

Rupee fall

The Indian rupee has been on the depreciation path in the last few months due to various factors such as widening trade deficit, rising crude oil prices, a surge in the dollar index after the US Federal Reserve hinted at fewer rate cuts in 2025, India’s sluggish growth in Q2FY25, and foreign investor outflows from equities.

This has led to the Indian rupee depreciating sharply in the last few months and hitting record lows almost every day against the US dollar.

To curb volatility in the local currency, the Reserve Bank of India (RBI) has been intervening in the market by selling dollars in the spot market and taking positions in the non-deliverable forward market. This has helped the local currency remain among the least volatile peers.

In the last three months, the Indian rupee has depreciated around 3.2 percent against the US dollar, while the South Korean won has sharply depreciated by 9.93 percent, followed by Japanese yen by 8.78 percent, Malaysian ringgit by 7.65 percent, and Thai baht by 6.07 percent, according to the Bloomberg data.

The data also showed that the Indian rupee is the second least volatile currency among its peers after the Hong Kong dollar, which depreciated 0.17 percent in the last three months.

The local currency depreciated to 86.6138 against the US dollar on January 14, from 83.8213 against the greenback on October 1, 2024.

Positive impact of depreciation 

Kanika Pasricha, Chief Economic Advisor at Union Bank of India, said that fundamentally rupee depreciation affects growth positively via the exports channel.

Exports within the growth sub-segment are positively affected though overall competitiveness plays a bigger role vis-a-vis rupee depreciation, Pasricha added.

However, India’s growth is set to dip to 6.4 percent in FY25, its lowest level in four years, pulled down by a likely decline in manufacturing and investment growth, according to preliminary data released by the government on January 7.

These estimates have come after India’s GDP growth in the second quarter of this fiscal slumped to its lowest level in seven quarters at 5.4 percent.

Even after this, RBI’s Financial Stability Report had said that real GDP growth was expected to recover in the third and fourth quarters of the current financial year on the back of pick up in domestic drivers, mainly public consumption and investment, strong service exports and easy financial conditions.

On December 26, the Finance Ministry said that India's economic growth is projected to reach around 6.5 percent in real terms for FY25, supported by strong rural and urban demand, improved capital formation, and robust government spending.