Why is the Indian Rupee falling

Why in the News?

The Indian rupee recently crossed ₹96 per U.S. dollar in May 2025, compared to nearly ₹85 a year earlier. This marked a sharp depreciation amid global geopolitical tensions, foreign portfolio outflows, and rising import dependence.

Why does the Indian rupee continue to depreciate despite India’s growing economy?

1. Demand-Supply Dynamics: Currency prices depend on market demand relative to other currencies. A higher demand for dollars than rupees weakens the rupee.
2. Import Dependence: India imports large quantities of crude oil, electronics, machinery, and industrial inputs, increasing demand for dollars.
3. Trade Deficit: India’s imports consistently exceed exports, creating a merchandise trade deficit.
   1. Data Point: Merchandise trade deficit worsened from USD 244.9 billion (2023-24) to USD 286.9 billion (2024-25).
4. Geopolitical Uncertainty: Global instability encourages investors to shift funds toward safer assets such as the U.S. dollar, strengthening it relative to emerging market currencies.
5. Dollar Strength: Higher U.S. interest rates attract global capital into dollar-denominated assets.

How does India’s Balance of Payments (BoP) shape the rupee’s exchange rate?

India’s Balance of Payments (BoP) directly shapes the rupee’s exchange rate by determining the net demand and supply of foreign currency within the economy.

1. Analyze Current Account ImpactThe Current Account reflects the net balance of trade in goods, services, and transfer payments
   1. Merchandise Trade Deficit: Increased from USD 244.9 billion (2023-24) to USD 286.9 billion (2024-25).
   2. Invisibles Surplus Buffers Rupee: Strong software services exports and remittances from workers abroad (especially West Asia) created a net invisible surplus rise from USD 218.8 billion to USD 263.9 billion. This creates massive inflows of foreign currency, supporting rupee stability.
   3. Net Deficit Weakens Rupee: Because the merchandise deficit outweighs the invisibles surplus, the overall current account remains in a deficit (CAD).
2. Evaluate Capital Account Dynamics: The Capital Account tracks the flow of investment capital, loans, and banking capital across national borders.
   1. Financing the Gap: India relies on foreign capital inflows to bridge the CAD.
   2. FDI and Portfolio Inflows: Inflows from Foreign Direct Investment (FDI) and Foreign Portfolio Investment (FPI) demand Indian currency. Foreigners convert USD to INR to buy assets, which strengthens the rupee.
   3. External Borrowing Risks: Relying on short-term loans and external borrowings can cause sudden rupee volatility if global interest rates spike or investors pull funds out rapidly.
3. Review Exchange Rate Outcomes: The final value of the rupee hinges on the net interaction between these two accounts.

BoP Condition	Market Mechanism	Impact on Indian Rupee
Overall BoP Surplus	Capital Inflows > Current Account Deficit	Appreciates (Rupee strengthens)
Overall BoP Deficit	Capital Inflows < Current Account Deficit	Depreciates (Rupee weakens)

India’s BoP Snapshot (Figures in USD billion)

Component	2023-24	2024-25
Current Account	-26.1	-23.1
Merchandise Trade	-244.9	-286.9
Invisibles	218.8	263.9
Capital Account	89.4	116.6
FDI	54.2	4.52
Loans	6.5	29.3
Others	28.7	-17.2
Forex Reserves Change	-63.7	+5

How do foreign capital outflows weaken the rupee?

Foreign capital outflows weaken the rupee through a direct market mechanism of asset liquidation and currency conversion.

1. The Conversion Mechanism: When foreign portfolio investors (FPIs) decide to exit the Indian market, they liquidate their holdings in domestic stocks and bonds. This process unfolds in two distinct steps that put downward pressure on the currency:
   1. Asset Liquidation: Investors sell Indian equities and debt instruments, receiving payments in Indian Rupees (INR).
   2. Currency Conversion: To repatriate their capital, these investors must immediately sell their newly acquired rupees in the foreign exchange market to buy US Dollars (USD).
2. Supply and Demand Imbalance: The mass exit of foreign capital disrupts the equilibrium of the foreign exchange market:
   1. Surplus of Rupee: The market experiences a sudden, heavy supply of rupees as exiting investors rush to dump the currency.
   2. Scarcity of Dollars: Simultaneously, the demand for US dollars spikes sharply.
   3. Depreciation: According to standard economic laws of supply and demand, an oversupply of a currency combined with intense demand for a foreign counterparty currency causes the domestic currency (the rupee) to lose value.
3. FPI vs. FDI Stability: The nature of the capital leaving the country dictates the severity of the exchange rate impact:
   1. High Volatility (FPI): Foreign Portfolio Investment is highly liquid and seeking short-term financial returns. It can exit a country almost instantly, earning it the label “hot money.” This makes FPI the primary driver of sudden, sharp currency depreciation during global market panics.
   2. Resilient Cushion (FDI): Foreign Direct Investment (FDI) involves long-term, physical investments like building factories or buying corporate infrastructure. Because these assets cannot be quickly liquidated, FDI remains stable during crises and serves as a critical structural anchor for the rupee.

Why does a falling rupee become costly for India’s economy?

1. Imported Inflation: Depreciation raises costs of imported goods.
2. Oil Burden: India imports a substantial share of crude oil, making energy prices vulnerable to currency depreciation.
3. Data Illustration: At ₹96 per dollar, purchasing USD 100 worth of oil requires ₹9,600, compared to ₹8,500 at ₹85 per dollar.
4. Inflationary Transmission: Higher fuel costs increase logistics and transportation expenses across sectors.
5. Manufacturing Constraints: Expensive imported raw materials raise production costs.
6. Growth Trade-off: Depreciation may support exports but simultaneously increases import dependence.

Does a weaker rupee improve India’s exports automatically?

1. Export Competitiveness: A cheaper rupee can make Indian goods more affordable globally.
2. Structural Constraints: Export gains remain limited when manufacturing competitiveness is weak.
   1. Even if the rupee depreciates from ₹96 to ₹120, export gains may remain modest due to supply-side constraints.
3. Import Dependence in Manufacturing: Many exporters rely on imported inputs, reducing net gains from depreciation.

What role does the Reserve Bank of India (RBI) play in defending the rupee?

1. Forex Intervention: RBI sells dollars from reserves to reduce excessive rupee depreciation.
2. Market Stabilisation: Dollar sales increase dollar supply in forex markets and support rupee demand.
3. Forex Reserve Strength: India’s reserves stood at approximately USD 691 billion by March 2026, sufficient for around 10.8 months of imports.
4. Intervention Evidence: RBI actively intervened during October 2024-January 2025 and August-December 2025.
5. Limitation: RBI can moderate volatility but cannot permanently reverse depreciation caused by structural deficits.

Why is oil dependency central to rupee vulnerability?

1. Crude Oil Imports: India imports nearly 85% of its crude oil requirement, increasing dollar demand.
2. External Vulnerability: Oil price shocks worsen trade deficits and strain forex reserves.
3. Geopolitical Linkage: Conflicts in energy-producing regions raise crude prices, amplifying pressure on the rupee.
4. Policy Imperative: Reducing oil dependence through renewables, EVs, ethanol blending, and domestic energy diversification strengthens currency stability.

Conclusion

The rupee’s depreciation reflects deeper structural realities of India’s external sector rather than merely short-term market fluctuations. Persistent trade deficits, dependence on imported oil, volatile portfolio flows, and geopolitical disruptions continue to pressure the currency. While RBI intervention and strong forex reserves provide temporary insulation, durable currency stability ultimately depends on strengthening exports, reducing import dependence, and improving external sector resilience.

PYQ Relevance

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

Linkage: The PYQ tests understanding of exchange rate volatility, external sector vulnerabilities, capital flows, and macroeconomic stability. The article explains how rupee depreciation, trade deficits, foreign capital outflows, geopolitical tensions, and dollar strengthening affect India’s macroeconomic stability and Balance of Payments.