By Subhadip Sircar and Anup Roy
India’s central bank is prepared to allow the rupee to weaken in tandem with the Chinese yuan following Donald Trump’s election victory, which has sparked concerns of higher tariffs on imports from China. According to sources familiar with the Reserve Bank of India’s (RBI) stance, the decision aims to counterbalance potential economic challenges resulting from a depreciating yuan, which could impact India’s trade dynamics with China—the country with which India has its largest trade deficit.
The rationale behind this move is that a weaker yuan would make Chinese exports cheaper, potentially causing an influx of Chinese goods and further widening India’s trade gap with China. The RBI, while poised to let the rupee depreciate, plans to manage the rate of decline through its considerable foreign exchange reserves to avoid sudden market shocks, the sources said, requesting anonymity due to the sensitivity of the topic.
Analysts revise rupee forecasts
In light of these developments, market analysts have adjusted their forecasts for the rupee’s value. HDFC Bank Ltd. predicts the rupee will breach the 85-per-dollar mark within the next 12 months. Meanwhile, IDFC First Bank Ltd. expects the currency to hit 84.50 earlier than its previous March projection. The rupee recently closed at 84.3750 against the dollar, marking its steepest weekly decline since May. Despite this dip, the rupee has maintained relatively low volatility compared to other emerging-market currencies, thanks in large part to the RBI’s interventions and strategic deployment of its foreign exchange reserves.
India currently holds the world’s fourth-largest forex reserves, valued at over $680 billion. These reserves enable the RBI to moderate the rupee’s fluctuations and curb sharp declines, positioning the currency as one of the more stable in Asia.
Impact of Trump’s trade policies on the Yuan and rupee
As China braces for potential yuan weakness in response to Trump’s trade stance, the ripple effects of his policies are expected to influence currency movements across Asia. Trump has previously proposed tariffs as high as 60% on Chinese imports, which could severely impact China’s export sector. If the yuan depreciates further to offset these tariffs, the effects could spill over, prompting weaker currencies across the region, including the Indian rupee.
With India’s trade deficit with China having doubled over the past three years to nearly $83 billion in 2023, a tightly controlled rupee in the face of a weakening yuan could further exacerbate the trade imbalance. Analysts at HDFC Bank, led by economist Abheek Barua, have suggested that “overvaluation concerns and the need to keep the rupee competitive” may lead the RBI to opt for a controlled depreciation of the rupee over the coming year.
Keeping the rupee competitive to support exports
India is eager to boost its manufacturing sector, particularly as companies look to diversify supply chains away from China. In recent years, India has made modest gains in export markets traditionally dominated by China, including electronics. A competitive rupee is seen as critical to sustaining and expanding this progress, as a stronger rupee would make Indian goods more expensive in global markets, hindering export growth.
To remain competitive with China, the RBI’s strategy appears to involve letting the rupee weaken gradually alongside the yuan, avoiding sudden shocks that could disrupt trade. This policy aligns with India’s broader economic goals, as the government has been actively encouraging foreign businesses to set up manufacturing operations domestically.
Historical context and market responses
The rupee and yuan have followed similar depreciation patterns against the US dollar throughout 2024. The rupee has fallen by approximately 1.4% against the dollar this year, while the yuan is down 0.9%. During Trump’s previous presidency, the yuan lost 11.5% of its value against the dollar between 2018 and 2019, helping to offset two-thirds of the tariff increases. Over the same period, the rupee depreciated by 11.2%.
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The RBI has been subtly managing the rupee’s movements relative to the yuan, given that around 40% of India’s trade deficit is with China. Madhavi Arora, lead economist at Emkay Global Financial Services Ltd., commented that “the RBI has been softly pegging INR against CNY” and is likely to continue this approach, allowing the rupee to weaken in a controlled manner instead of allowing it to float freely in response to market forces.
A strategic move Amid global uncertainties
As global economies brace for potential disruptions from Trump’s trade policies, the RBI’s approach aims to balance domestic economic stability with international competitiveness. With a weakening yuan likely to reduce Chinese export prices, a similar depreciation of the rupee could protect India’s exports from becoming uncompetitive.
The RBI’s strategy is ultimately focused on maintaining India’s economic resilience amid global uncertainties. By allowing the rupee to weaken alongside the yuan, the central bank can help protect India’s trade interests, support its burgeoning manufacturing sector, and ensure that India remains an attractive location for companies diversifying supply chains outside of China. The central bank’s interventions, backed by substantial forex reserves, are expected to limit extreme volatility and sustain the rupee’s relative stability in the face of evolving global challenges.
