By Prabhat Patnaik
In recent days, Indian newspapers have been filled with reports on the depreciation of the rupee against the US dollar. Just over a month ago, on November 27, the exchange rate was Rs 84.559 for one dollar; by December 29, it had climbed to Rs 85.5. This decline has occurred despite the Reserve Bank of India’s attempts to stabilize the rupee by dipping into foreign exchange reserves. The reserves, which totaled $657.89 billion on November 22, fell to $644.39 billion by December 20, yet this could not halt the rupee’s decline; without utilizing reserves, the depreciation would likely have been even steeper.
Historically, the rupee’s depreciation against the dollar has been a long-standing issue. For a significant period during the dirigiste era, the rupee’s value against the dollar was fixed, occasionally altered by government-decreed devaluation, sustained through currency control. However, once these controls were lifted, the rupee has consistently weakened. Following the liberalization in 1991 when the rupee was first floated, it started at Rs 22.74 to the dollar; by the time Narendra Modi took office in 2014, it had reached Rs 62.33, and now it has exceeded Rs 85.5.
This persistent depreciation is not solely due to higher inflation rates in India compared to the US; while that is indeed a factor, it is not the primary reason behind the rupee’s weakening. In fact, one significant contributor to India’s higher inflation rates is the rupee’s depreciation, which increases import costs for essential goods like oil, leading to higher prices across the economy. Although various causes may influence the rupee’s depreciation, inflation does react back on the exchange rate as speculators anticipate further declines, exacerbating the situation. Ultimately, the primary driver of the rupee’s depreciation is the trend among wealthy Indians to hold their assets in US dollars rather than in rupees, creating a consistent flow from rupees to dollars.
This phenomenon of ongoing depreciation is not unique to India; it occurs in many developing nations. This is a key reason why the rupee’s exchange rate should not be left to float freely, but rather should be pegged against the dollar and supported by capital and foreign exchange controls, similar to the system in place during the dirigiste era.
However, this long-term fall of the rupee is uneven, with periods of accelerated decline followed by slower downturns. Therefore, one might ask: what has triggered the recent rapid depreciation of the rupee? Discussions in the media have focused on reasons such as India’s higher inflation compared to the US and an expanding trade deficit. Yet, an overlooked factor is the dollar’s strengthening not just against the rupee, but against nearly all major currencies globally. This suggests that the dollar’s recent gains are not purely based on India-specific conditions but are influenced by broader dynamics. Currently, the dollar is experiencing its highest strength in a decade: the Bloomberg Dollar Spot Index has risen by 7 percent this year, marking the highest level since 2015.
At first glance, this strengthening of the dollar may seem paradoxical. Recently, US President-elect Donald Trump announced proposed tariff increases once he takes office. In the face of such protectionist policies, one would expect a loss of confidence in the US market, leading to a depreciation of the dollar. However, market analysts are instead pointing to Trump’s protectionist stance as a reason for the dollar’s strength. How can this contradiction be explained?
The straightforward explanation lies in the fact that the rhetoric championing free trade is often directed at unsuspecting politicians in developing countries rather than reflecting market realities. It is clear that US protectionism will boost domestic demand, thereby enhancing production and employment by restricting imports that have undercut local producers. Consequently, while US protectionism may improve its employment situation, it could also bolster the US trade balance, enhancing overall aggregate demand.
In summary, the US could potentially strengthen its balance of payments and improve employment and production through protectionist strategies. As a result, market confidence in the US economy has improved, contrary to what advocates of free trade might argue. This increased faith translates into greater confidence in the dollar, enhancing its exchange rate against other currencies.
While US protectionism may elevate inflation in America, it is likely to spur even higher inflation in the rest of the capitalist world. Since the prices of several essential commodities, particularly critical inputs like oil, are set in dollars, a stronger dollar translates into higher prices for these commodities when expressed in other currencies, contributing to inflationary pressures in those economies.
Workers in these regions will therefore face declining living standards for two main reasons: first, job losses from reduced access to the American market due to US protectionism; and second, rising inflation from the cost-driven effects of their currencies depreciating against the dollar. Should governments in these countries pursue austerity measures aimed at controlling inflation—potentially leading to increased unemployment and diminished bargaining power for workers—it will further deepen their impoverishment.
In the case of third-world countries burdened with foreign debt, the situation is compounded by an additional challenge: the rising value of their external debt in local currency terms, which is typically denominated in US dollars. This will result in escalated debt servicing costs, disproportionately impacting workers in those nations.
What is unfolding in the global economy highlights a fundamental irrationality of the capitalist system, wherein the livelihoods of millions hinge on the volatile decisions of speculators. Although an increase in aggregate demand in the US might signal growth due to protectionist policies, its repercussions on global exchange rates primarily stem from speculative behavior—an essential variable within capitalism. (IPA Service)
