The Indian rupee has faced meaningful downward pressure in 2025, reaching a record low of Rs 90 per US dollar while underperforming the vast majority of emerging market currencies. This depreciation has been driven by a confluence of domestic economic strains and a challenging global context. Despite these immediate pressures, India’s underlying economic fundamentals demonstrate resilience, suggesting the market reaction might be overstating short-term concerns while overlooking structural improvements. A closer examination is warranted.
Key factors driving rupee depreciation
The primary force behind the Rupee’s decline stemmed from an imbalance in the country’s external account, capital outflows and weak sentiment.
Widening trade deficit: A significant contributor to this sell off is the widening trade deficit, which hit a staggering record high of $42 billion in October. This gap, signifying imports significantly exceeding exports, naturally increases the demand for foreign currency, like the US dollar, relative to the Rupee, thereby weakening the latter. A key factor here is surging gold imports which exacerbated the trade imbalance. This high demand is largely driven by entrenched cultural practices and the festive season, leading to a large outflow of foreign exchange to pay for the precious metal.
US tariffs on Indian exports: Adding to the external friction, the implementation of a 50% tariff hurt Indian exports, widening the trade deficit. While rumours of a possible trade deal sometime in 2025 had been making the rounds, as the year comes to a close with no material progress, this delay weighs on sentiment. It is noteworthy that INR depreciation will help in absorbing the impact of higher tariffs versus other emerging market countries, where tariffs are lower.
Foreign portfolio investor outflows: It is no secret that valuations in the equity market have been stretched. Additionally, as nominal growth, which is real growth plus inflation, has been coming down for a few quarters now, Indian capital markets have experienced a substantial outflow of foreign money, with FPIs withdrawing nearly $17 billion from Indian equities this year. This large-scale capital outflow directly reduces the supply of dollars in the Indian market, putting pressure on the Rupee.
Global interest rate differentials: The difference in interest rates between US and Indian Government bonds was near 5% in 2021-22 and has fallen to less than half that at below 2.5% currently. The lower this spread, the more attractive US dollar-denominated assets become, drawing capital away from emerging markets like India and weakening their currencies.
India’s underlying economic fundamentals
While the Rupee’s exchange rate warrants attention, an analysis of India’s economic metrics reveals a picture of improving stability and incremental strength.
Narrowing current account deficit: A crucial sign of improving external balance is the narrowing of the current account deficit, which improved to 0.7% of GDP in FY2024/25. A smaller deficit means the country is increasingly funding its imports through exports rather than relying on dollar borrowing or foreign portfolio flows. To better understand the scale of this improvement, the current account deficit was close to 5% in 2013, during the Taper Tantrum episode when the US Federal reserve started ending its policy of easy liquidity.
Large foreign exchange reserves: India maintains a massive financial safety net, with foreign exchange reserves close to $700 billion. Critically, this amount covers 11 months of imports, providing a substantial buffer against external shocks and the ability to intervene in the currency market. Importantly, FX reserves are close to double that in 2013.
Support from services, remittances and oil: The economy is being bolstered by improving services exports, which are gaining global market share, and record remittances from the Indian diaspora. Furthermore, lower oil prices contribute to managing the overall trade balance and the near term outlook on oil is helpfully supportive given large additional crude supply expected to come online in 2026.
Global context and strategic shifts
The Rupee’s challenges are set against a backdrop of significant shifts in the global economic and geopolitical landscape, which also present strategic opportunities for India.
De-dollarization: India is astutely but not overtly participating in the global de-dollarization trend, establishing alternative currency settlement and promoting Rupee trade, particularly with the UAE and Russia. This long-term strategy aims to reduce the country’s reliance on the US dollar-based financial system, mitigating risks from dollar fluctuations and US policy.
Shifting global supply chains: India stands to benefit from the restructuring of global supply chains, and thanks to significant reforms, is now an attractive destination for manufacturing (the subject of a previous column). This trend, often labelled the ‘China Plus One’ strategy, promises long-term Foreign Direct Investment (FDI) inflows and significant increases in exports, which will structurally strengthen the Rupee over time.
Policy response
The Indian government and the Reserve Bank of India (RBI) have deployed several tools to manage Rupee weakness.
RBI’s intervention: The RBI has intervened directly in the currency market to dampen volatility. This was done by selling dollars from its reserves, resulting in a drawdown of almost $40 billion in reserves year to date. The RBI acts to smooth market movements and generally does not defend any arbitrary level.
Trade agreements and partnerships: India is proactively strengthening its global economic ties through trade agreements and partnerships, including those with the UK, and EU, aimed at boosting exports and securing preferential market access.
Export promotion mission: This framework was announced in the 2025 Union Budget to bolster export competitiveness, particularly given high external tariffs. The EPM provides financial interventions like affordable trade credit and guarantees, especially for MSMEs, and focuses on non-financial support such as international branding, logistics and compliance to enhance market access.
In summary, the Indian Rupee is facing challenges from high imports, lower exports and capital outflows. The persistence of global economic uncertainty and geopolitical tensions are, however, fairly mitigated by India’s large external buffers, policy response and strategic actions. Therefore, the immediate outlook remains one of watchful caution but not alarm. Over the medium term, India’s strengthening economic core, characterized by continuing reform and steady economic progress, positions it well to navigate this complex global landscape and capitalize on opportunities for growth. As always execution remains key and so, for now, it’s time to pull up our socks.
Disclaimer
Views expressed above are the author’s own.
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