By Kitdor H. Blah
Introduction: The Rupee has been consistently depreciating against the Dollar since India adopted the market driven floating exchange rate system in 1993. So is the root cause of Rupee depreciation a systemic problem of the floating exchange rate? But the Rupee has depreciated since the 1980s which forced us to devalue our currency in 1991 and leave the fixed exchange rate system in 1992. India has also consistently outpaced the US in inflation since then. So does the root cause of Rupee depreciation lie in domestic policy? But the high interest rates of the US Federal Reserve also contributed to Rupee depreciation in the 1980s. We must look at the history of the US Dollar as the world’s reserve currency because this system makes Rupee depreciation necessary. We must look at the recent changes in US-India tariffs because it has added pressure to an already weak Rupee and widened the Current Account Deficit (CAD) or the difference between the Dollars we spend and the Dollars we receive. A high CAD means we have less Dollar reserves to pay for our imports and debts. We must look at the price of crude oil in the world because when it rises, we have to sell more rupees and buy more dollars. This adds pressure to an already weak Rupee, high inflation, and the CAD. We must also look at national policies because fiscal deficits, high inflation, a weak Rupee and widening CAD are too familiar to us, going back to the 1991 Balance of Payments crisis.
The Gold Standard: Before WW2, countries had a domestic gold standard, i.e. their currencies were domestically valued relative to a weight of gold. For example, in the US, it was 20.67 Dollars per ounce of gold and the British Pound was 4.24 pounds per ounce. Nations only printed as much currency as there were gold reserves to meet the set value per weight of gold. The exchange rate between currencies was the ratio of their value per weight of gold, e.g. the exchange rate between Dollar and Pound was 20.67/4.24 = 4.86, i.e. 1 Dollar = 4.86 Pounds. Whenever there were wide trade deficits or debts between countries, this deficit or debt would be paid in gold, thereby reducing the volume of gold reserves at home, and the corresponding amount of currency was removed from circulation. Therefore, trade deficits did not cause inflation like in our current exchange rate system, but deflation, as prices and wages would fall to correspond to the reduced amount of currency.
The International Gold Standard (Bretton-Woods Agreement): After WW2, the main impetus was to establish a stable and peaceful world economy to allow war torn economies to rebuild. This required an objectively valued medium of exchange to eliminate currency manipulations or fluctuations and ensure fair and stable global trade. The US Dollar was established as the reserve currency for nations to trade with each other because the US owned more than 60% of all the gold in the world. The Dollar had a fixed exchange rate with gold, i.e. 1 Troy Ounce of Gold (31 grams) = 35 Dollars. Other currencies had a fixed exchange rate with the Dollar. e.g. 1 Pound = 4.03 Dollars. Other currencies that were not directly pegged to the Dollar had a fixed exchange rate with those currencies that were pegged to the Dollar, e.g., 1 Pound = 13.33 Rupees.
A brief history of the Dollar as the Reserve Currency: The US eventually printed Dollars in excess of its gold reserves. The need to fund the Vietnam War in 1965 made this practice more excessive. The inflated amount of Dollars compared to the stable amount of gold meant that the dollar had actually depreciated and was over-valued relative to gold. In 1965, the French President Charles De Gaulle described this practice of the US as an “exorbitant privilege.” In 1971, he threatened to redeem France’s dollar reserves for gold. This would have triggered a gold shortage and hyper-inflation in the US. Thus, in 1971, President Nixon ended the convertibility of the US Dollar into Gold, and in 1973, he ended the fixed exchange rate between the Dollar and gold. From that moment, the value of the world’s reserve currency was left to the market forces of demand and supply, which in turn were shaped by interest rates and comparative domestic inflation between countries.To keep the Dollar as the world’s reserve currency, the US entered into a 50 year agreement with Saudi Arabia in 1974, where Saudi Arabia would price and sell its oil in US Dollars and the US would provide military protection in return. This arrangement was adopted by other Gulf countries and all OPEC countries.
How the US Dollar exports inflation to countries like India: Today, the US Dollar as the world’s reserve currency is valued by the market forces of demand and supply. Countries like India who rely heavily on US Dollar in the international market for imports, exports, for issuing debts, and for servicing its debts, are disproportionately affected by this market driven floating exchange rate system. 86% of India’s imports are invoiced in Dollars. Therefore, even if all things remain the same at home, when the Dollar strengthens, imports become disproportionately costlier for India, as we need more rupees for every Dollar of imported goods. The cost of these imports is ultimately paid by consumers, which increases other local prices too. When imported raw materials become costlier, the cost of production for domestic industries also increases. India’s manufacturing sector has a high dependency on imported raw materials. All these factors create inflation. This imported inflation can be caused by the US simply increasing its interest rates. In the 1980s, the high interest rates in the US known as the Volcker Shock, when the US Federal Reserve raised interest rates upto 20%, causing investors to dump Rupees for Dollars, also contributed to the depreciation of the Rupee which made imports more expensive. Moreover, 54% of India’s debt issuances are denominated in Dollars. When the Dollar strengthens, the cost of servicing/repaying these Dollar denominated debts suddenly becomes costlier as we need more Rupees for every Dollar of debt. This also depreciates the Rupee and depletes our Dollar reserves. On the other hand, 88% of India’s exports are invoiced in Dollars. Thus, when the US lowers interest rates, prints more Dollars or issue Dollar denominated debts in the international market, it increases the supply of Dollars, decreasing its value. This makes our exports more expensive as countries need more Dollars to buy our exports. In such cases, we are forced to depreciate our currency, to make our exports less expensive and more competitive. But a depreciated currency again makes imports costlier and repeats the process of imported inflation. Imported inflation increases cost of production and makes our exports more expensive again. Those economists who say that they will not lose sleep over the Rupee crossing the 100 Dollar mark because it will make exports more competitive ignore the fact that our major exports such as petroleum products, pharmaceuticals and electronics have a high dependency on imported raw materials, ranging from 40% to 80%.
Effects of US Tariffs: The US is our single largest market. Even until two years ago, we imposed very high tariffs on US goods, from 39% to 100% in many cases. The US imposed low tariffs on Indian goods, averaging about 13 to 16%. However, for the last 12 to 16 months, the US has imposed high tariffs on Indian goods from 18% to 50%. In return for an 18% tariff on our major exports like electrical equipments, precious stones and pharmaceutical products, India has to reduce tariffs on US industrial materials and agricultural goods to 0%, when it used to be 13% to 39%. Compared to just two years ago, our exports to the US are getting more expensive while our imports from the US are getting less expensive. This also widens the CAD and adds to the depreciation of the Rupee.
Rise in Crude Oil Prices:The price of crude oil was 55 Dollars per barrel in late 2025. The Iran War started on 28th February, 2026. In the first week of March, it jumped to 78 Dollars per barrel and quickly breached the 100 Dollars mark. The last time it breached the 100 Dollars mark was in 2022, following years of low crude oil price from 2016 to 2021. The rising oil prices automatically depreciate the Rupee since we need to spend more Rupees to buy more Dollars to pay for imports. The high oil prices continue the process of imported inflation, which will further make our exports more costly and less competitive. This cannot continue or it will widen the CAD and create a Balance of Payment crisis.
Conclusion: While domestic policy, fiscal deficit and inflation, are the primary causes of currency depreciation, yet under the gold standard, this was auto-corrected by a high trade deficit which then causes deflation. The floating exchange rate system makes currency depreciation systemic and makes the Rupee vulnerable to US interest rates, investors’ behavior, demand and supply, and creates a vicious cycle between inflation and currency depreciation.
