Mounting rupee pressure weighs on India’s external trade

Why in the News

The rupee has depreciated about 9% against the US dollar over a year, moving from around Rs 87.5 to Rs 95.4 to the dollar. The fall exposes how far India’s trade balance now depends on external shocks it does not control, rather than on domestic competitiveness.

What is the Real Effective Exchange Rate (REER)?

1. Meaning: The Real Effective Exchange Rate (REER) is the value of the rupee against a trade weighted basket of partner currencies, adjusted for inflation differences between the countries.
2. What it signals: A falling REER means Indian goods are becoming cheaper abroad in real terms, which should aid exports but also signals weakening currency strength.
3. Recent movement: The REER fell between 9% and 11.7% over the period, tracking the nominal depreciation of the rupee.

What is driving the rupee’s depreciation?

1. US tariff action: US tariffs on Indian goods rose as high as 50% from August 2025, before being reduced to 10% from February 2026, disrupting export earnings.
2. Portfolio outflows: Foreign Portfolio Investors (FPI) pulled capital out of Indian markets, reducing dollar inflows and pressuring the currency.
3. West Asia conflict: The conflict around the Strait of Hormuz raised crude oil prices, widening the oil import bill.
4. Structural import dependence: India remains dependent on imports for electronics, Active Pharmaceutical Ingredients (API) and critical minerals, keeping import demand high regardless of the rupee’s level.

Why does the depreciation worsen rather than correct the trade gap?

1. Widening deficit: The trade deficit widened to $333.6 billion in 2025-26, showing that a cheaper rupee has not narrowed the import bill.
2. Inelastic imports: Import dependence on energy and critical inputs means volumes do not fall much when the rupee weakens, so the import bill rises in rupee terms.
3. Export limits: Tariff barriers in key markets cap the export gains a weaker rupee would normally deliver.

What are the challenges to stabilizing the rupee and the trade balance

1. Import concentration: Heavy reliance on a few import categories, energy, electronics and critical minerals, leaves the deficit exposed to global price swings.
2. Reserve drawdown: Defending the rupee through Reserve Bank of India (RBI) dollar sales draws down foreign exchange reserves and cannot continue indefinitely.
3. Imported inflation: A weaker rupee raises the cost of imported fuel and inputs, feeding into domestic inflation.
4. Capital flow volatility: FPI flows can reverse quickly with shifts in US interest rates, making the rupee vulnerable to sudden outflows.
5. Manufacturing gap: Without deeper domestic manufacturing of electronics and pharmaceutical inputs, the structural import bill stays high across cycles.

Conclusion

The rupee’s slide is driven mainly by external forces, US tariffs, portfolio outflows and oil prices, not by weaker domestic fundamentals alone. A cheaper currency has failed to correct the trade deficit because import demand is inelastic and export gains are capped by tariffs. Reducing import dependence in energy, electronics and critical minerals is the only durable route to a stronger external position.

PYQ Relevance

[UPSC 2020] With reference to the international trade of India at present, which of the following statements is/are correct?

1. India’s merchandise exports are less than its merchandise imports. 2. India’s imports of iron and steel, chemicals, fertilisers and machinery have decreased in recent years. 3. India’s exports of services are more than its imports of services. 4. India suffers from an overall trade/current account deficit.

Select the correct answer using the code given below: (a) 1 and 2 only (b) 2 and 4 only (c) 3 only (d) 1, 3 and 4 only

Answer: (d)