Why in the News?

The Indian rupee touched a historic low of around ₹91.98 per US dollar in early 2026, prompting concerns over macroeconomic stability. The Economic Survey 2025-26 identifies this episode as part of a broader global capital reallocation rather than a domestic crisis. This is significant because the Survey explicitly rejects the “currency underperformance equals weak fundamentals” assumption, even as India records strong growth, controlled inflation, and stable agricultural output. The issue is large in scale: foreign portfolio investors withdrew about $41 billion in January alone, pushing total outflows in 2025 close to $11.8 billion, making external capital volatility a first-order macroeconomic risk.

Why Has the Rupee Been Underperforming Despite Strong Fundamentals?

1. External Capital Outflows: Sustained withdrawal of foreign portfolio investments in equity and debt segments exerts downward pressure on the rupee despite stable domestic indicators.
2. Magnitude of Outflows: Portfolio investors withdrew nearly $41 billion in January 2026, with cumulative outflows of $11.8 billion in 2025, indicating scale rather than episodic volatility.
3. Domestic Counterbalancing: Mutual funds and insurance companies provided partial support, but domestic flows were insufficient to neutralise foreign exits.
4. Investor Risk Perception: Global uncertainty induces portfolio rebalancing away from emerging markets, irrespective of individual country performance.

How Do Capital Inflows Shape Rupee Stability?

1. Balance of Payments Dependence: India relies on foreign capital inflows to maintain a manageable balance of payments position.
2. Liquidity Transmission: Sudden contraction in inflows tightens dollar liquidity, amplifying exchange rate volatility.
3. Capital Flight Risk: The Survey flags capital flight as a key near-term risk, especially during periods of global financial stress.
4. US Dollar Dominance: Heightened demand for dollar assets during uncertainty weakens emerging market currencies uniformly.

What Role Do Global Trade and Tariff Shocks Play?

1. US Tariff Escalation: Steep tariff increases by the US, including potential 50% duties, create uncertainty for exporters.
2. Export Disruption: While outbound shipments remain resilient so far, exporters face order delays and price renegotiations.
3. Inflation Transmission: Higher tariffs on Indian goods may indirectly affect investment sentiment rather than immediate inflation.
4. Investor Hesitation: Trade uncertainty discourages long-term capital commitments, increasing exchange-rate sensitivity.

Why Is Manufacturing Not Enough to Stabilise the Currency?

1. Limited Export Offset: Manufacturing strength alone cannot fully compensate for trade deficits in goods.
2. Structural Gap: Services exports and remittances provide support but do not substitute industrial export depth.
3. Industrial Capacity Constraint: Currency resilience requires diversified, complex manufacturing with scale.
4. Policy Sequencing: Export competitiveness must precede exchange-rate stability, not follow it.

What External Risks Dominate the 2026 Outlook?

1. Global Scenario Volatility: The Survey outlines three global scenarios, baseline recovery, disorderly breakdown, and systemic shock.
2. Capital Flow Sensitivity: Even moderate global shocks trigger disproportionate capital outflows from emerging markets.
3. Institutional Fragility: Weaker global shock absorbers increase contagion risk across trade, finance, and currencies.
4. Strategic Sobriety: The Survey calls for preparedness rather than optimism, given external uncertainty.

What Policy Response Does the Survey Advocate?

1. Liquidity Planning: Strengthens preparedness for sudden capital outflows through buffer creation.
2. FDI Expansion: Prioritises stable long-term capital over volatile portfolio flows.
3. Import Financing Resilience: Ensures uninterrupted financing for essential imports.
4. Payment Diversification: Encourages diversification of trade routes and settlement systems.

Conclusion

The Economic Survey 2025-26 reframes rupee depreciation as an externally induced phenomenon rooted in global capital cycles rather than domestic macroeconomic weakness. Currency stability, therefore, depends less on short-term exchange-rate management and more on long-term structural resilience, particularly stable capital inflows, diversified exports, and robust external buffers.

PYQ Relevance

[UPSC 2018] How would the recent phenomena of protectionism and currency manipulations in world trade affect macroeconomic stability of India?

Linkage: This PYQ directly tests how global protectionism and currency manipulation transmit external shocks into India’s exchange rate. The Economic Survey 2025-26 reinforces this by showing that rupee weakness is driven mainly by global trade tensions and volatile foreign capital flows.

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