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By Nimesh Vora and Jaspreet Kalra
MUMBAI (Reuters) - India's central bank could tolerate a sharper depreciation of the rupee if China lets the yuan weaken to cushion the impact of U.S. tariffs, multiple sources aware of the central bank's thinking said.
China and India compete in exports such as machinery, electronics, pharmaceuticals, chemicals and textiles and three people familiar with the Reserve Bank of India's (RBI) thinking said the central bank had become increasingly focused on the yuan exchange rate over the last few months.
As well as making Indian exports less competitive, a weaker yuan could widen India's already large trade deficit with China.
"The RBI has been relatively hands-off (this year). The rupee is automatically adjusting based on how currencies are moving globally, so the hands-offs approach will mostly continue," one of the sources said.
The RBI did not immediately respond to a Reuters email seeking comment.
U.S. President Donald Trump last week imposed an additional 34% "reciprocal" tariff on Chinese imports, on top of an existing 20% levy, making the cumulative tariff burden imposed on China under the current Trump administration the highest in Asia, weighing on the country's growth outlook.
Beijing is expected to respond with a mix of fiscal stimulus and interest rate cuts, while potentially stepping back from currency stability and allowing the yuan to depreciate.
"Currency stability in China in the face of such a large tariff schedule entails large economic costs and is ultimately unlikely to be sustainable," analysts at Barclays Bank said in a note.
Goldman Sachs said in a report on Sunday that the new tariff rates would reduce Chinese GDP growth by at least 0.7% this year. Barclays Bank downgraded its forecast by 30 basis points to 4.0% for 2025.
A weaker yuan would have negative spillover effects for the rupee and the rest of Asia.
"Typically, USD/Asia would follow the direction of the broad dollar," Goldman Sachs said in its report. "However in this instance, we think dollar/yuan exchange rate will provide an important anchor for Asian currencies," and they will be watching how the dollar/yuan fix evolves this week.
The onshore yuan dropped to 7.3192 to the U.S. dollar on Monday, the lowest in four months. In response, the Indian rupee weakened 0.7% to 85.85 to the dollar, headed for its worst day in nearly three months.
The rupee is still above a record low of 87.95 touched on Feb. 10 when a slowdown in India's economic growth prompted equity outflows.
China is India's largest trading partner and India ran a trade deficit of $94 billion with China in 2024, underscoring its dependence on Chinese imports.
India's central bank will monitor moves in the yuan closely, considering the growing importance of China trade, investment and third-country competitiveness in exports, Barclays said.
"Currency movements among all major trading partners and the denomination of invoicing is something that the RBI looks at," one of the sources said, referring to the fact that most of India's imports are dollar-denominated.
(Reporting by Nimesh Vora and Jaspreet Karla, additional reporting by Swati Bhat; Editing by Susan Fenton)
