Relevance: GS-3 (Trade & External Sector) | Source: The Indian Express

1. The Core News Context

In May 2026, the Indian Rupee (INR) hit a record low, crossing the 96-per-dollar mark.

This 5.2% drop is driven by the West Asia crisis and a delayed market reaction. In 2023-2024, the Reserve Bank of India (RBI) used its reserves to artificially hold the Rupee at 82-83. Now that the RBI has stepped back, the market is aggressively correcting itself.

2. Core Economic Concepts

• Managed Floating System: India’s exchange rate is decided by the market (demand and supply of dollars). The RBI intervenes only to stop wild swings, not to fix a permanent price.
• Depreciation vs. Devaluation: Depreciation is a natural fall in currency value due to market forces. Devaluation is an official reduction by the government.
• The “Artificial Stability” Issue: Currencies naturally lose value over time due to inflation. By burning reserves to stop this natural slide earlier, the RBI built up pent-up market pressure, resulting in today’s sudden slump.

3. Why is the Rupee Falling Now?

• Capital Flight: Global wars create panic. Foreign investors are pulling money out of India and moving it into safe-haven US assets, increasing dollar demand.
• Costlier Crude Oil: The West Asia crisis has spiked oil prices. Since India imports 85% of its crude oil, we need more dollars to pay our import bills, which weakens the Rupee further.

4. Economic Impact on India

• Imported Inflation: Everyday imports like fuel, edible oils, and electronics become costlier, driving up domestic prices.
• Wider Current Account Deficit (CAD): Our import bill grows much larger than our export earnings.
• Costlier Foreign Debt: Indian companies that borrowed in dollars (External Commercial Borrowings) must now spend more Rupees to repay the same loans.

5. UPSC Value Addition

• Real Effective Exchange Rate (REER): An inflation-adjusted metric showing the Rupee’s actual trade competitiveness against a basket of foreign currencies.
• FEMA, 1999 (Foreign Exchange Management Act): The administrative law that empowers the RBI to manage foreign exchange.
• Special Rupee Vostro Accounts (SRVAs): Bank accounts that allow India to settle international trade in Rupees instead of US Dollars, reducing our dollar dependency.

Consider the following statements regarding the Indian Rupee and exchange rate dynamics:

1. The Real Effective Exchange Rate (REER) is adjusted for inflation and acts as an indicator of a country’s export competitiveness.
2. In India’s managed floating exchange rate system, the RBI strictly targets and fixes a maximum value for the Rupee against the US Dollar.
3. Currency depreciation occurs due to market forces of demand and supply, whereas currency devaluation is an official government policy action.

Which of the statements given above are correct?

(a) 1 and 2 only

(b) 2 and 3 only

(c) 1 and 3 only

(d) 1, 2 and 3

Correct Answer: (c) 1 and 3 only