🌑Knowledge Drop – 50: The Falling Rupee: A Mirror to Global Volatility and India’s Structural Choices | For Prelims: InDepth MCQs| For Mains, All G.S Papers: High Quality Essays
🌐 Knowledge Drop – 50
The Falling Rupee: A Mirror to Global Volatility and India’s Structural Choices
4 December 2025
Syllabus: GS-3 | Indian Economy, External Sector, Monetary Policy
🔍 Context
Recent depreciation of the Indian rupee against major global currencies such as the US dollar, euro, and yen reflects not merely short-term global volatility but also deeper structural pressures within India’s external sector.
💱 What Does Rupee Depreciation Mean?
Rupee depreciation refers to a decline in the value of the Indian rupee vis-à-vis foreign currencies, implying that more rupees are required to purchase one unit of foreign currency.
📉 This has direct implications for imports, inflation, capital flows, and macroeconomic stability.
⚙️ Key Drivers Behind Rupee Depreciation
🧾 Trade Deficit Pressure
When imports consistently exceed exports, demand for foreign currency rises, exerting downward pressure on the rupee.
💸 Capital Outflows
Foreign portfolio investors exiting equity and debt markets reduce foreign currency inflows, weakening the exchange rate.
💵 Global Dollar Strength
High US interest rates and safe-haven demand strengthen the dollar, causing emerging market currencies like the rupee to depreciate.
📊 Inflation Differentials
Higher inflation relative to trading partners erodes purchasing power and weakens currency competitiveness over time.
🌍 Geopolitical & Economic Uncertainty
Global conflicts, financial tightening, or domestic instability dampen investor confidence, triggering currency volatility.
📉 Why the Current Depreciation Matters
🔢 Nominal & Real Exchange Rate Trends
- NEER fell from 90.75 (Jan 2025) to 84.58 (Oct 2025) – a 6.8% decline
- REER corrected from 108.06 (Nov 2024) to 97.47 (Oct 2025) – a 9.8% fall
📌 This shift marks a transition of the rupee from overvalued to undervalued, improving export price competitiveness.
🧮 Inflation Cushion Effect
India’s CPI inflation (Oct 2025): 0.25%, far lower than the US, UK, Euro Area, and other major economies.
➡️ Low inflation has softened the real impact of nominal depreciation.
📚 NEER vs REER — Why They Matter
- NEER (Nominal Effective Exchange Rate): Weighted average of rupee against a 40-currency basket
- REER (Real Effective Exchange Rate): NEER adjusted for inflation differentials
📉 A fall in REER indicates improved external competitiveness, but prolonged undervaluation can import inflation.
🧨 Economic Implications of a Weaker Rupee
🔥 Inflationary Pressures
Costlier imports, especially oil (80% import dependence), trigger cascading effects on transport, food, and manufacturing.
🏭 Corporate Profitability Risks
Firms with high import dependence or foreign currency borrowings face margin stress.
🚢 Trade Balance Constraints
While exports gain price advantage, structural import dependence on oil and electronics limits net benefits.
💼 Investor Sentiment
Currency volatility deters foreign investment, aggravating capital outflows.
🏦 IMF Reclassification & RBI’s Policy Stance
📘 IMF’s Assessment (Nov 26, 2025)
India’s exchange rate regime reclassified as a “crawl-like arrangement”, allowing gradual movement within a controlled band.
🧭 RBI’s Current Approach
- Selective intervention to smooth volatility
- Focus on export competitiveness
- Cautious use of forex reserves
⚠️ Excessive intervention risks:
- Depleting forex reserves
- Importing inflation
- Constraining monetary policy flexibility
🔮 What Lies Ahead?
📌 Continued nominal depreciation with subdued inflation may keep the rupee competitively undervalued in the near term.
However, sustaining stability will demand a delicate balance between:
- Currency flexibility
- Inflation control
- Capital flow management
🌱 A Thought Spark — IAS Monk
“A currency does not weaken merely by falling in value.
It weakens when policy, productivity, and confidence fall out of balance.”
Target IAS-2026+: Highly Expected Prelims MCQs :
📌 Prelims Practice MCQs
Topic:
MCQ 1 | TYPE 1 — How Many Statements Are Correct?
Consider the following statements regarding rupee depreciation in India:
1)Rupee depreciation means more units of domestic currency are required to purchase one unit of foreign currency.
2)A persistent trade deficit can exert downward pressure on the rupee.
3)Higher domestic inflation compared to trading partners strengthens the real exchange value of the rupee.
4)Capital outflows reduce the supply of foreign currency in domestic markets.
How many of the above statements are correct?
A) Only two
B) Only three
C) All four
D) Only one
🌀 Didn’t get it? Click here (▸) for the Correct Answer & Explanation.
🟩 Correct Answer: B) Only three
🧠 Explanation:
1)✅ True – This is the basic definition of currency depreciation.
2)✅ True – Higher imports increase demand for foreign currency.
3)❌ False – Higher inflation erodes purchasing power and weakens REER.
4)✅ True – Capital outflows reduce forex availability.
MCQ 2 | TYPE 2 — Two-Statement Type
Consider the following statements:
1)A strong US dollar often leads to depreciation of emerging market currencies like the Indian rupee.
2)Rupee depreciation automatically guarantees a sustained improvement in India’s trade balance.
Which of the above statements is/are correct?
A) Only 1 is correct
B) Only 2 is correct
C) Both are correct
D) Neither is correct
🌀 Didn’t get it? Click here (▸) for the Correct Answer & Explanation.
🟩 Correct Answer: A) Only 1 is correct
🧠 Explanation:
1)✅ True – Higher US interest rates strengthen the dollar.
2)❌ False – Structural trade deficits and weak global demand can offset gains.
MCQ 3 | TYPE 3 — Code-Based Statement Selection
With reference to NEER and REER, consider the following statements:
1)NEER is a weighted average of bilateral exchange rates without adjusting for inflation.
2)REER reflects the real competitiveness of a currency by adjusting NEER for inflation differentials.
3)A fall in REER indicates appreciation of the domestic currency.
Which of the above statements are correct?
A) 1 and 2 only
B) 2 and 3 only
C) 1 and 3 only
D) 1, 2 and 3
🌀 Didn’t get it? Click here (▸) for the Correct Answer & Explanation.
🟩 Correct Answer: A) 1 and 2 only
🧠 Explanation:
1)✅ True – NEER is nominal and inflation-neutral.
2)✅ True – REER adjusts for relative price levels.
3)❌ False – A fall in REER signals weakening, not appreciation.
MCQ 4 | TYPE 4 — Direct Factual Question
According to the IMF’s November 2025 assessment, India’s exchange rate regime has been reclassified as:
A) Free-floating arrangement
B) Stabilised arrangement
C) Crawl-like arrangement
D) Fixed exchange rate regime
🌀 Didn’t get it? Click here (▸) for the Correct Answer & Explanation.
🟩 Correct Answer: C) Crawl-like arrangement
🧠 Explanation:
IMF classified India’s regime as crawl-like, allowing gradual currency adjustments within a defined band.
MCQ 5 | TYPE 5 — UPSC 2025 Linkage Reasoning Format (I, II, III)
Consider the following statements:
Statement I:
A decline in India’s REER suggests improved export competitiveness.
Statement II:
Lower domestic inflation combined with nominal rupee depreciation reduces the real exchange value of the rupee.
Statement III:
Structural trade deficits limit the long-term gains from currency depreciation.
Which one of the following is correct?
A) Both Statement II and Statement III are correct and both explain Statement I
B) Both Statement II and Statement III are correct but only one explains Statement I
C) Only one of the Statements II and III is correct and that explains Statement I
D) Neither Statement II nor Statement III is correct
🌀 Didn’t get it? Click here (▸) for the Correct Answer & Explanation.
🟩 Correct Answer: B)
🧠 Explanation:
✅ Statement II directly explains why REER declines and competitiveness improves.
✅ Statement III is correct but highlights limitations rather than explaining Statement I.