Despite widespread optimism, Donald Trump’s return as President may ignite economic turbulence, complicating the RBI’s efforts to manage a falling rupee, shrinking forex reserves and trade uncertainties.
External Affairs Minister S Jaishankar asserted that, unlike most nations, India remained bullish about ties with the US through Trump’s second term in the Oval office, reflecting broader optimism among Indian leaders. Echoing the EAM’s sentiment, Commerce and Industry Minister Piyush Goyal described the American President-elect as a "friend of India" and predicted improved bilateral relations in his tenure. The situation on the ground, however, appears more vexed.
Many economists believe that the Reserve Bank of India (RBI) was deliberately allowing the INR to fall against the US dollar to protect India’s competitiveness against China. The rupee’s fall started on the results day, plunging to a record low of 84.76 on December 3, primarily due to flight of foreign funds and strengthening of the US dollar in global markets.
With forex reserves declining for eight consecutive weeks by about $48 billion, from an all-time high of $705 billion on September 27, the RBI had no choice but to intervene in the market and stabilise the domestic currency against the dollar.
“Markets expect more global uncertainty and higher US inflation and interest rates resulting in ‘safe haven’ trade when capital flows return to the US. The RBI has very effectively used reserves to smoothen the effects of such capital flow surges,” said Ashima Goyal, former RBI monetary committee member and professor at the Indira Gandhi Institute of Development Research.
Forex reserves essentially contain US dollar assets held by the RBI. They also include some amounts in the Euro, Japanese yen, and the British pound. When the Indian currency becomes volatile or depreciates sharply, the RBI sells forex to restore balance. The RBI carefully buys dollars when the rupee is strong and sells them when it weakens, which helps make Indian investments more attractive to investors.
With the INR hitting a record low, the central bank has been forced to sell forex reserves to mitigate its depreciation. While generally optimistic about Trump’s India policies, many insiders acknowledge that maintaining a smooth trade relation with US may be more challenging going forward.
“In the medium to long term, structural changes in the trade scenario will be a critical factor. Significant shifts in tariffs could influence the direction of exports and imports, inevitably leading to further depletion of forex reserves,” said Professor Sahana Roy Chowdhury at International Management Institute, Kolkata.
While India expected to enjoy a competitive advantage over China with US imposing heavy tariffs on China, it seems unlikely that India would remain unaffected by Trump’s hawkish tariff policies. In his previous term as president, the MAGA leader had slapped a 25 per cent tariff on imports from Mexico and Canada and an additional 10 per cent on goods coming from China. These moves justifiably stoked hopes in India that it would continue to enjoy a competitive advantage over China and countries like Mexico. However, Trump’s November 30 threat of 100 percent tariffs on imports from BRICS nations, including India, if they attempted to undermine the US dollar as the global reserve currency, has cast a shadow on that sanguine outlook.
India has been actively trying to promote the use of local currencies in trade to mitigate disruptions caused by sanctions and US dollar shortages. In collaboration with countries like Russia, the UAE, and Singapore, India has been leveraging its own payment systems and local currency. As a result, India must navigate this evolving situation with strategic caution
Economists have praised the RBI’s decision to maintain rates, inflationary pressure remains a significant concern for the country’s economy. Should the US impose high tariffs on imports, it could spark a surge in prices in the US, driving inflation across global economies. The impact of inflationary pressures in the US might not be immediate evident, but it would be unwise to ignore these signals. “Inflationary pressure (in the US) has major repercussions on other economies. With inflation rising in the US, there are chances that it will eventually trickle down to other economies like India,” said Roy Chowdhury. She cautioned that if there are tariff hikes to favour domestic players and or tighten strategic relations, it would be inflationary.
Economists agree that the RBI’s policy stance will help India navigate a potentially tricky situation. Now, it is time to wait for Trump’s next move to figure out what the RBI must do to secure India’s growth trajectory without allowing inflation to spiral out of control. In response to surging prices, the US Fed might be compelled to increase rates again, forcing other central banks to follow suit, reigniting a wave of inflation.
“Then with such inflationary pressures, there are chances of tighter Monetary policy , which will have ramifications in the emerging economies including India, and they are then likely to witness further capital outflow,” added Roy Choudhury. And further capital outflow will lead to depleting forex reserves again.
With Trump coming to power, RBI needs to be cautious about two major hurdles that could affect the Indian economy. Firstly, the central bank needs to balance the forex reserves and the depreciation of Indian currency and secondly, it must safeguard the Indian economy from the volatility in the US.
"Some volatility aids price discovery and hedging. RBI’s interventions, like selling reserves, help reduce excess volatility and prevent misalignment of the exchange rate. Since the pandemic, the rupee’s volatility has been lower than many peers. A 0.5per cent depreciation after stability is manageable, compensating for higher inflation. India should leverage this by improving business conditions and pursuing a US FTA to attract trade and diversify away from China, while protecting its consumer goods industry from cheap Chinese imports.",” said Goyal.