Context

• The recent decline in the value of the Indian rupee has caused considerable concern among market participants and the general public.
• What makes this episode particularly puzzling is that it has occurred despite strong macroeconomic fundamentals.
• India currently enjoys robust economic growth, historically low inflation, and a manageable current account deficit, conditions that typically support currency stability.
• The depreciation of the rupee, therefore, cannot be adequately explained through conventional economic indicators.
• Instead, it reflects the growing influence of geopolitical tensions and capital flow volatility, especially arising from strained trade relations with the United States.

Strong Macroeconomic Fundamentals

• India’s macroeconomic performance remains strong by both domestic and international standards.
• Economic growth is estimated at 7.4% for the current year, reinforcing India’s position as one of the fastest-growing major economies.
• Inflation has been remarkably subdued, with consumer price inflation falling to 1.33% by the end of 2025, well below the Reserve Bank of India’s lower tolerance band for several consecutive months.
• The external sector also appears stable, with the current account deficit amounting to only 0.76% of GDP in the first half of 2025–26, a significant improvement over the previous year.
• Despite these favourable indicators, the rupee has depreciated by around 6% since April 2025.

Reason Behind Rupee Depreciation

• Capital Outflows as the Primary Cause
  • A closer examination shows that the primary driver of the rupee’s decline is not the trade deficit but capital outflows.
  • Although India’s merchandise and services trade deficit widened modestly during April-December 2025, it remains within manageable limits and does not justify the magnitude of the currency’s fall.
  • In contrast, capital flows have undergone a sharp reversal. Net capital inflows of over $10 billion during April–December 2024 turned into net outflows of nearly $4 billion in the corresponding period of 2025.
  • This reversal has exerted significant downward pressure on the rupee and reflects deteriorating investor sentiment rather than economic weakness.
• Geopolitical Tensions and U.S. Trade Policy
  • These capital outflows are closely linked to geopolitical developments, particularly the increasingly adverse trade stance of the United States toward India.
  • The imposition of a cumulative 50% tariff on Indian exports, initially on a reciprocal basis and later due to India’s import of Russian crude oil, has heightened uncertainty among investors.
  • Additional threats of tariffs on countries trading with Iran, despite India’s limited trade exposure, have further intensified fears.
  • As tariffs are increasingly weaponised for geopolitical objectives, economic fundamentals have taken a back seat in shaping investment decisions.

Shift from Economic to Diplomatic Determinants and the Role of the Reserve Bank of India

• Shift from Economic to Diplomatic Determinants
  • This episode marks a departure from earlier instances of rupee depreciation.
  • In 2022, for example, the rupee’s fall could be explained by global economic factors such as aggressive interest rate hikes by the U.S. Federal Reserve.
  • The present depreciation, however, lacks a clear economic rationale and is driven largely by non-economic pressures.
  • Consequently, the challenge has moved from the economic arena to the diplomatic sphere, implying that conventional macroeconomic tools alone are insufficient to address the problem.
• Role of the Reserve Bank of India
  • In this context, the role of the Reserve Bank of India is important but constrained.
  • Since the adoption of a market-determined exchange rate regime in 1993, the RBI has intervened in foreign exchange markets primarily to reduce volatility rather than to fix the rupee’s value.
  • Although volatility has never been formally defined, RBI actions indicate that it includes moderating sharp and disruptive depreciations.
  • Such intervention seeks to minimise the costs of sudden exchange rate shocks while allowing the currency to adjust gradually.

Why Rupee Depreciation is Not a Solution?

• The argument that rupee depreciation could stimulate exports is weak under present conditions.
• India’s exports increasingly depend on imported inputs, reducing the competitive advantage gained from a weaker currency.
• Moreover, high tariffs in the U.S. market significantly limit export growth. On the import side, India relies heavily on essential commodities, particularly crude oil, which accounts for a large share of total imports.
• A weaker rupee would raise import costs and risk fuelling inflation, undermining price stability.

Conclusion

• The recent decline in the value of the rupee is primarily the result of capital outflows driven by geopolitical tensions rather than weak economic fundamentals.
• As long as uncertainty over trade relations with the United States persists, downward pressure on the rupee is likely to continue, with potential spillover effects on financial markets.
• While the Reserve Bank of India can smoothen volatility, a lasting solution lies in diplomatic engagement.
• An early and credible understanding between India and the United States is essential to restore investor confidence, stabilise capital flows, and ensure long-term currency stability.