Why the US Dollar Is Costlier Than the Indian Rupee: Understanding the Reasons and Future Outlook
Why the US Dollar Is Costlier Than the Indian Rupee: Understanding the Reasons and Future Outlook
The value of the US Dollar (USD) compared to the Indian Rupee (INR) has been a topic of interest for decades. As of now, $1 equals approximately ₹83, reflecting a significant gap in value. The key question is: Why is the US dollar consistently stronger than the Indian rupee? Let’s explore the key reasons behind this and assess whether this trend will continue in the future.
1. Differences in Economic Strength and Stability
The US is the world’s largest economy with a nominal GDP of over $27 trillion in 2024, compared to India’s nominal GDP of around $3.8 trillion. The US economy’s global dominance gives the dollar significant strength.
Example 1: The US has a strong and stable financial system, with the US Federal Reserve playing a critical role in controlling inflation and ensuring financial stability.
Example 2: In India, while the growth rate is higher, the country still faces structural challenges like external deficits, inflation, and slower reforms that limit INR appreciation.
2. Inflation Rate Differences: A Major Factor
Inflation erodes the purchasing power of a currency. Historically, India has had a higher inflation rate compared to the US, leading to continuous depreciation of the rupee.
Current Inflation Data (December 2024):
US: 2.9% annual inflation
India: 5.22% annual inflation
Example 1: Over the last 30 years, the rupee has depreciated at an average rate of 3.5% to 4.5% per year against the dollar, reflecting higher inflation in India.
Example 2: From 1995 ($1 = ₹35) to 2023 ($1 = ₹83), the depreciation shows how long-term high inflation impacts currency value.
3. Demand for the US Dollar: The Global Reserve Currency
The US dollar is the world’s primary reserve currency, used in 60% of global foreign exchange reserves and for most international trade transactions.
Example 1: Most oil-importing countries, including India, pay for oil imports in USD, leading to higher demand for dollars.
Example 2: During crises like COVID-19 and the 2008 financial crisis, investors moved to USD assets, strengthening the dollar and weakening the rupee.
4. Trade Deficit and Capital Flows
India imports more than it exports, leading to a trade deficit. In 2024, India’s trade deficit was around $250 billion, mainly due to high oil and gold imports. This deficit increases pressure on the rupee.
Example 1: The large trade deficit causes continuous outflows of foreign exchange, increasing demand for USD and weakening the rupee.
Example 2: When foreign investors withdraw capital, as seen in 2022 when the Fed raised rates, the rupee depreciates due to reduced inflows.
5. Government Debt and Fiscal Discipline
The US government has high debt, but it can manage that debt through low borrowing costs and strong global demand for US Treasuries. In contrast, India’s fiscal deficit and foreign debt put pressure on the rupee.
Example 1: India’s fiscal deficit of around 6.4% of GDP in 2023 raises concerns about debt sustainability and INR depreciation.
Example 2: The US’s ability to attract investors to its debt instruments helps keep the dollar strong despite its high debt levels.
Will the US Dollar Continue to Be Stronger Than the Indian Rupee in the Future?
Short-Term (Next 5-10 Years): The dollar is expected to remain strong due to its status as a global reserve currency and consistent demand.
Long-Term (Beyond 10 Years): As India’s GDP grows closer to $10 trillion by 2035, its fundamentals may improve, and structural reforms could reduce the depreciation rate.
Steps India Can Take to Strengthen the Rupee
1. Controlling inflation through effective monetary policy.
2. Boosting exports and reducing dependency on oil imports through renewable energy.
3. Encouraging FDI and domestic manufacturing.
4. Managing the fiscal deficit and ensuring stable public finances.
Conclusion
The US dollar’s strength over the Indian rupee is due to multiple factors: inflation differentials, global demand, trade imbalances, and economic fundamentals. While the dollar will likely remain stronger in the near future, India’s ongoing reforms could slow down the depreciation rate and lead to a more stable rupee.
By addressing challenges in inflation, exports, and fiscal discipline, India can potentially alter its currency trajectory and emerge as a global economic powerhouse.
What do you think? Will India be able to strengthen the rupee in the long run? Share your thoughts!