The graph of the Indian rupee has been snaking sharply downward. The rupee-to-dollar exchange rate, or the rupees needed to purchase a U.S. dollar, crossed 96 in May this year. That rate was around 85 a year ago, indicating the rupee’s decline in value since then.

Exchange rate is the price that a currency, such as the rupee, commands in the market, relative to the dollar or other currencies. Just as the market price of onions is determined by demand and supply, so is the price of a currency.

What is the impact of trade deficits on the rupee’s value?

The demand for the rupee rises with India’s exports and falls with imports. When firms in Ludhiana export garments, the dollars or euros they receive from foreign buyers are exchanged for rupees to pay workers and suppliers, thereby increasing demand for the rupee. On the other hand, Indian companies import oil by exchanging rupees for dollars, thereby reducing the demand for the rupee. Rupee demand also declines when we travel abroad and exchange rupees at the airport for the currency of our destination country.

Overall, if India’s imports exceed exports, the foreign currency payments it must make to the rest of the world exceed the foreign currency payments it receives. That implies more rupees are exchanged for dollars than dollars are exchanged for rupees, leading to declines in the demand for, and the value of the rupee (requiring more rupees to purchase one dollar).

Thus, a currency’s exchange rate is closely tied to the country’s balance of (foreign currency) payments (to and from the rest of the world). India has consistently run a merchandise trade deficit, with imports of goods (especially oil) exceeding exports. The deficit in its merchandise trade account is partially offset by a surplus in India’s invisibles. That is mainly thanks to foreign currency inflows from the export of services, particularly software, and to the large remittance inflows from migrant workers, especially in West Asian countries. Overall, India’s current account, which is the sum of merchandise trade and the invisibles accounts, has been in deficit (Table 1).

The gap in the current account, between the foreign currency payments India owes to the rest of the world and the foreign currency payments it receives, has been bridged by inflows through the capital account, mainly foreign investment and loans. If the current account deficit is more than offset by a surplus in the capital account, the excess foreign currency received is added to the country’s foreign exchange (or forex) reserves (Table 1).

How do capital outflows weaken the rupee?

A country’s forex reserves are as valuable as a family’s treasure trove. The reserves are tapped to pay for critical imports during periods of insufficient foreign currency inflows, and to defend the currency’s value when capital outflows are too large (discussed below).

Foreign direct investment (FDI) is mostly in new or existing factories and businesses and, as a result, has some ties binding it to the host country. In comparison, foreign portfolio investment (FPI), which involves purchases of stocks or bonds, is highly volatile and driven by speculation. Portfolio investors enter a country seeking quick financial returns and exit at the first sign of risk or when higher returns are offered elsewhere. When FPI surges in, the stock markets are on a roll; when it flows out, it leaves a trail of destruction. Capital outflows imply that investors withdraw their investments in rupee assets and exchange them for dollar assets, leading to a tumble in demand for the rupee and in its exchange rate.

The periods of rapid depreciation of the Indian rupee have each been characterised by worsening of the trade account, FPI outflows, or both. These include April to September 2013 (when the rupee-to-dollar rate fell from 54.4 to 63.8); January to October 2018 (from 63.6 to 73.6); February to April 2020 (from 71.5 to 76.2); January to October 2022 (from 74.4 to 82.3); September 2024 to February 2025 (from 83.3 to 87.1); and the latest phase that began in May 2025 (from 85.2 to 96) (Chart 1). The recent losses in the rupee have mainly been due to foreign investors withdrawing from India as they retreat to the safety of their home bases amid growing geopolitical tensions and higher U.S. interest rates.

The depreciation of the rupee imposes a high cost on the Indian economy. To purchase a barrel of oil at $100, Indian companies now must pay ₹9,600, compared to ₹8,500 had the exchange rate remained at ₹85 per dollar. However, a depressed rupee can help boost exports: a shirt costing ₹1,200 can be sold in the U.S. market at $12.5 now; if the exchange rate were ₹80 per dollar, the price would have been $15. But rupee depreciation alone may not help much, given the range of supply and demand constraints weighing on Indian manufacturing.

What is the role of the RBI?

The Reserve Bank of India (RBI) intervenes to prevent the exchange rate from falling to very low levels. When foreign investors rush out by selling their rupee assets for dollars, the RBI props up the rupee by selling some of the dollars (or treasury bonds) from its reserves. This raises the demand for rupee and slows its decline (as it did during October 2024-January 2025 and August-December 2025) (Chart 2). India’s forex reserves remain sufficiently large: they stood at around USD 691.11 billion at the end of March 2026, enough to cover 10.8 months’ worth of the country’s imports (as of the end of December 2025). That is a mighty armoury the RBI can deploy to shield the rupee against impending speculative tides.

The ongoing geopolitical tensions and the threat of further oil price increases pose severe challenges. India could be at risk of paying more dollars per barrel of oil and more rupees per dollar. The country must take steps to regulate speculative capital outflows and reduce its dependence on oil imports.

(Jayan Jose Thomas is a Professor of Economics at the Indian Institute of Technology Delhi, and a visiting researcher at the South Asia Institute of the University of Heidelberg.)

Published – May 26, 2026 07:30 am IST

Continuous days of sustained losses has seen the rupee close at almost ₹97 to the dollar, with no indication that the slide has been arrested. Rising oil prices and the threat of external inflation will put further pressure on the rupee in the days to come. This has prompted calls for intervention to prevent further falls.

Some writers, like Harvard professor Gita Gopinath, have resisted calls for intervention by the RBI, advocating for letting the rupee find its own level. A weaker rupee would automatically curtail imports and boost exports. Intervention would only obstruct the free flow of market forces.

While intervention does have its challenges, there is danger in letting the process of depreciation continue unabated, especially when much of it is being driven by speculative finance. With foreign interest rates bound to rise, capital will flow out faster, leading to stronger negative pressures on the rupee. In such a scenario, it might take inordinately long for the rupee to ‘find its level’, and the inflationary dangers of a weak rupee will exert even more stresses on a populace already exposed to hardship as a result of worldwide spikes in energy prices.

Can intervention deepen volatility?

A current account deficit implies more imports than exports, and hence a greater need for foreign currency. If this is adequately met by foreign capital inflow to purchase assets like stocks, the rupee’s value relative to the dollar will not change.

If the economy experiences a deficit without sufficient inflow of foreign capital, it faces a problem, with demand for foreign exchange exceeding available supply. Mainstream models dictate that in such a situation, the rupee must depreciate. The weaker rupee makes exports more affordable and imports more expensive, leading to an automatic adjustment of the current account deficit relative to the available inflow of foreign capital.

In such a scenario, intervening to artificially prop up the value of the rupee only delays the inevitable. It inhibits adjustment by ensuring import demand does not fall, because the rupee has not depreciated enough to naturally shut off higher import demand, the cause of the widening deficit in the first place.

What is the difference between a weak rupee and a falling rupee?

Arguments for non-intervention, however, conflate a falling rupee with a weak rupee. A fall in the rupee value would not automatically increase export demand if the market expects a further fall. Exports might be higher when the rupee is weak, but may not rise when the rupee is falling if foreign buyers expect the price to fall even further and for goods to become cheaper at a later date.

At the same time, if the economy imports essential goods like oil, demand may not automatically reduce sufficiently as the rupee falls. If people expect the rupee to fall further, and for the prices to rise even more tomorrow, they may front-load purchases today and increase import demand in the short run. This can be seen in the rush to buy petrol when prices were raised, as consumers expected further increases in the future.

A falling rupee would see higher import values, but no necessary increase in exports, ensuring that the deficit is not curtailed. The very problem that required a depreciation might just perpetuate itself. One might argue that exports would pick up and imports reduce when the process eventually works itself out. But the adjustment process is rarely painless. Rising import values of essential goods will lead to rising inflation in the domestic economy that has already experienced reverse migration and real wage squeezes.

What is the role of capital flows?

For the sake of argument, one can posit an equilibrium value of the rupee driven by fundamental values, such as export and import demands that exhibits uniform and predictable behaviour as the rupee changes value. The process may be long, but the economy might eventually settle at this value, driven by fundamental changes in the current account. However, this assumption neglects the role of speculative foreign capital.

Much of the fall in the rupee has been driven by speculative outflows of foreign institutional investment that, for whatever reason, does not see Indian assets as being sufficiently remunerative. Perhaps investors think returns on Indian stocks will not be high in the future, that growth is not sustainable, or that interest rates will rise in developed country markets. Whatever the reason, these speculative expectations of foreign investors can lead to capital outflow and depreciation, necessitating current account adjustments based on the sentiments of foreign investors.

In such a situation, the ‘actual’ value of the rupee is determined not by consumption demand but by speculation. There are no fundamentals or technical values underpinning the pure speculation of financial markets. With indications that foreign Central Banks may soon raise interest rates, the rupee could come under further pressure.

Intervention is one amongst many policies that must be considered, and one that even developed economies have resorted to. As the yen slid against the dollar in April this year, Japanese Finance Minister Satsuki Katayama signalled that the government would take ‘decisive action’ in financial markets to maintain the yen. This announcement did lead to the yen recovering some losses initially after the announcement, though it continues to lose ground due to limited actual intervention.

Intervention to stem speculative capital flows is extremely hard to manage, and can lead to negative outcomes if the force of speculation is too great, or if governments do not – or cannot – show enough commitment in markets. However, we must not assume that the rupee can find an equilibrium value soon, for its fall is being driven by speculation rather than any fundamental economic behaviour. It is time to have a serious conversation regarding the role and place of foreign capital in India’s growth story. 

(Rahul Menon is associate professor at O.P. Jindal Global University.)

Published – May 22, 2026 07:30 am IST