What are the reasons for the record low exchange rate at the end of 2025?
External Drivers: The Aftermath of Fed Policy and the "Asymmetric Impact" of the Dollar Index
The currency depreciation wave at the end of 2025 stems primarily from profound changes in the global liquidity landscape, with the Fed's policy adjustments being the core driving force behind this transformation. Although the Fed announced its second interest rate cut of the year on December 11, 2025, lowering the federal funds rate to the 4.25%-4.5% range and officially ending the aggressive rate hike cycle since 2022, dollar assets still maintain a significant yield advantage compared to the Bank of Japan's 0.5% and the Reserve Bank of India's 5.0% benchmark interest rates.
Data shows that as of the end of December 2025, the interest rate differential between Japan and the US remains as high as 500 basis points. This historic interest rate differential provides fertile ground for carry trades by Wall Street hedge funds. Hedge funds borrow large amounts of low-interest yen and then invest in high-interest US Treasury bonds, forming a closed loop of "borrowing-investing-profiting." Market analysts estimate that hedge funds' short positions in the Japanese yen doubled in December 2025 alone. This consistent short-selling created a market expectation of a "inevitable yen depreciation," further amplifying the currency's decline.
It's worth noting that the US dollar index exhibited a "structurally weak but relatively strong" trend. The dollar index fell by approximately 9.9% in 2025, marking its worst annual performance since 2003, but this decline was primarily driven by the collective appreciation of major non-US currencies such as the euro. For currencies with weak fundamentals, such as the yen and rupee, the relative attractiveness of the dollar did not diminish. Luo Zhiheng, chief economist at Yuekai Securities, pointed out that the core logic of the current global exchange rate market has shifted from traditional interest rate parity to a dual pricing mechanism of "dollar strength/weakness cycles + economic fundamental divergence." This is a key reason why some emerging market currencies still experienced severe depreciation despite the overall weakening of the dollar index.
Besides interest rate differentials, US trade policies also became a direct trigger for the depreciation of some currencies. In August 2025, the United States imposed a total of 50% tariffs on most Indian goods imported into the US, including a 25% base tariff and a 25% punitive tariff. This policy directly led to a sharp decline in Indian exports to the US. In September, Indian exports to the US fell to $5.5 billion, a 20.3% decrease month-on-month, and the trade deficit subsequently widened to $32.15 billion, a 13-month high. The sharp expansion of the trade deficit directly weakened the rupee's exchange rate support, becoming a major factor driving it to fall below the 90 mark at the end of the year.
Internal Problems: The Concentrated Outbreak of Policy Mistakes and Structural Economic Contradictions
If external factors are the "catalyst" for currency depreciation, then policy mistakes and structural contradictions within the economy are the "fundamental problems." In this wave of depreciation, the fundamental economic weaknesses of Japan and India were fully exposed, becoming the core targets for market short selling.
Japan's predicament stemmed from the "internal conflict" between fiscal and monetary policies. After the Sanae Takaichi government came to power, it launched an economic stimulus plan totaling 21.3 trillion yen, attempting to boost the economy through large-scale fiscal investment. However, this measure was essentially a "poisoned chalice"—the stimulus funds relied mainly on issuing government bonds, while Japan's debt exceeded 260% of its GDP, ranking first among major global economies. A panic sell-off ensued in the government bond market, with the 40-year yield soaring to a record high of 3.695%, and the 20-year yield also rising to a new high since 1999 at 2.815%.
The passive adjustment of monetary policy further exacerbated market panic. To address the turmoil in the government bond market and inflationary pressures, the Bank of Japan symbolically raised interest rates to 0.5% in 2025. However, this rate hike failed to curb inflation (core CPI rose year-on-year for 50 consecutive months, with rice prices rising by 40.2%), nor did it narrow the interest rate differential with the US dollar. Instead, it led to increased corporate financing costs and a contraction in manufacturing activity. Data shows that Japanese manufacturing activity suffered its biggest drop in 19 months, with export orders in key sectors such as automobiles and semiconductors shrinking for 44 consecutive months. Real wages have declined for nine consecutive months, and consumer confidence has repeatedly hit new lows, plunging the economy into a vicious cycle of deflation, currency devaluation, and difficulty in increasing income.
India's problems are concentrated in its trade imbalance and energy dependence. As a major energy importer, India has long suffered from a current account deficit, with energy import expenditures accounting for over 30% of its total imports. Fluctuations in global energy prices in 2025 will further exacerbate its balance of payments pressures, while declining exports due to US tariffs will further intensify this contradiction. More seriously, international capital's confidence in the Indian economy continues to weaken, with foreign investors net selling over $17 billion in Indian stocks in 2025. Importers are buying foreign currency in advance to hedge against risks due to weakening expectations, while exporters are delaying settlements in anticipation of currency stabilization. This combination of a "buying spree" and "delayed settlement" further amplifies the depreciation pressure on the rupee.
The long-term accumulation of structural contradictions has also left both countries without a "buffer" to cope with currency depreciation. Japan faces a severe problem of low birth rate and aging population, with nearly 30% of its population aged 65 and over. The aging rate in rural areas and remote islands has soared to 76%, highlighting problems such as labor shortages, lack of medical resources, and aging infrastructure. The lagging transformation of its manufacturing sector also constrains its competitiveness. Its bet on hydrogen fuel cell technology in the new energy vehicle sector has fallen behind the global trend of electrification, gradually lagging behind the industrial upgrading pace of China and the United States. India, on the other hand, is constrained by weak infrastructure and an incomplete industrial chain. Its industrial development relies excessively on external capital and technology, lacking core competitiveness in the restructuring of the global supply chain and finding it difficult to improve its trade balance through export growth.
Market Chain Reaction: The Transmission of Depreciation and the Difficult Breakthrough in the Currency Defense Battle
The sharp depreciation of the yen and rupee has triggered a regional chain reaction, forcing several export-oriented economies in Asia to join the "currency defense battle," significantly increasing volatility in the global exchange rate market.
The Reserve Bank of India (RBI) intervened urgently in the market after the rupee fell below the 90 mark, at one point selling approximately $100 million per minute, but the effect was minimal. Market analysis points out that although India's foreign exchange reserves are around $600 billion, the effective reserves after deducting short-term foreign debt are insufficient to support long-term exchange rate stability. More seriously, the depreciation has triggered imported inflationary pressures, with prices of imported goods such as oil, electronics, and fertilizers rising sharply, further pushing up the cost of living for residents and production costs for businesses, severely impacting India's economic recovery.
The Japanese government's efforts to rescue the market are caught in a dilemma. Previously, Japan attempted to counter short selling by selling $30 billion in US Treasury bonds, but was met with warnings and threats of sanctions from US Treasury Secretary Yellen. Ultimately, Japan was forced to increase its holdings of US Treasury bonds by $94.4 billion, losing its initiative to stabilize the exchange rate through foreign exchange intervention. Faced with the dual pressures of a debt crisis and currency depreciation, the Bank of Japan is caught in a vicious cycle: raising interest rates exacerbates the risk of debt default, while not raising rates allows capital outflows, leading to a complete collapse of its policy credibility.
This depreciation pressure has begun to spread to neighboring economies. Export-oriented Asian countries such as South Korea and Thailand have also recently shown signs of currency depreciation. The Bank of Korea has intervened in the foreign exchange market twice, while Thailand has stabilized its exchange rate by adjusting its foreign exchange reserve ratio. Industry experts worry that if the depreciation trend of the yen and rupee is not curbed, it could trigger regional competitive currency depreciation, damaging the recovery momentum of the Asian economy.
Expert Outlook: When Will the Depreciation Wave End? Policy Adjustment Direction is Key
Regarding the exchange rate trend in 2026, industry experts generally believe that whether the depreciation pressure on the yen and rupee can be alleviated depends crucially on the combined effects of internal policy adjustments and changes in the external environment. Luo Zhiheng points out that the pace of the Federal Reserve's interest rate cuts will be a crucial external variable. If the Fed continues to increase its rate cuts in 2026, the US dollar index may weaken further, narrowing the interest rate differential between Japan and the US, which will alleviate the depreciation pressure on the yen. However, for India, even with a weaker dollar, its fundamental problems of trade imbalances and energy dependence remain unresolved, and the rupee will still face periodic depreciation pressure.
Addressing internal structural contradictions is the long-term solution. For Japan, experts suggest abandoning its "fiscal stimulus dependency" and improving its economic fundamentals through pension reform, deregulation of the labor market, and increased investment in new energy industries, while strengthening cooperation with regional economies and reducing dependence on the US Treasury market. For India, it needs to optimize its trade structure, reduce its dependence on energy imports, and attract long-term capital rather than short-term speculative capital by improving the business environment to enhance the stability of its balance of payments.
The reform of the global economic governance system has also been put on the agenda. Experts point out that this wave of currency devaluation highlights the fragility of the current global exchange rate system. Emerging market countries should strengthen monetary cooperation, promote the construction of a diversified international reserve currency system, reduce dependence on a single currency, and enhance their ability to withstand external financial shocks.
The currency devaluation wave at the end of 2025 is both an inevitable result of global liquidity restructuring and a concentrated outbreak of long-accumulated structural contradictions in some economies. For countries like Japan and India, this devaluation crisis is both a challenge and an opportunity to promote economic reform. In the future, only through profound policy adjustments and structural reforms can they truly break free from the vicious cycle of exchange rate fluctuations and achieve stable and sustainable economic development. For the world, how to build a more equitable and reasonable international financial order and prevent the spread of regional currency crises will become an important issue for global economic governance in 2026.
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