Rupee is falling but is it alarming?
The rupee's recent slide has sparked concern, but is it truly a sign of economic stress or just a reflection of global forces at play?
Should we worry about the falling rupee? The situation looks concerning but not a crisis, provided GDP growth, investment, and external buffers remain sound. India’s GDP growth remains the fastest among major economies of the world. The external buffer in terms of forex reserves is the fourth highest in the world. Private investment has increased. NIPFP’s FY26 note says aggregate investment growth rose 9.4% in Q4 FY25 after 6.2% in the previous three quarters.
However, it also mentions that private investor sentiment will remain muted in FY26. The muted response and uncertainty exist for almost all countries except the US, which is forcing capital to flow there. Tech disruption coupled with wars has added to the challenges. So why is the rupee falling?
HISTORICAL CONTEXT
Historically, international trade has been known to create prosperity. However, there have been periods of protectionism. For instance, the Smoot-Hawley Act (1930) in the US and global retaliation led to the Great Depression of the 1930s. This was followed by the era of import substitution from 1950–70. Efforts were later made through the General Agreement on Tariffs and Trade (GATT) to enhance global trade and improve resource allocation and market access.
The Uruguay Round negotiations (1986–94) led to GATT being replaced by the World Trade Organisation (WTO), established on January 1, 1995. This reflected a global resolve to increase international trade for better utilisation of resources and broader market access, creating prosperity for the world.
Countries like China and India were capital-scarce and opened their doors to foreign direct investment (FDI). The IMF advised developing countries to open up to FDI and trade. Rich countries invested in poorer ones. Ironically, higher FDI inflows became an indicator of economic strength, even for developing economies.
A weaker currency in exporting (poorer) countries also helped boost exports. It suited developed nations as well, which shifted low-end and polluting manufacturing to developing economies and gained access to cheaper goods. Crude oil and gas being denominated in US dollars created sustained global demand for the dollar, giving the US an ability to print more dollars and purchase global goods. The world broadly functioned within this arrangement.
India benefited significantly. In 2001, India’s GDP was around $485 billion, ranking 13th globally. By 2010, GDP rose to $1.68 trillion and the ranking improved to 9th. Net FDI into India remained positive during this period. Meanwhile, the rupee weakened even as the economy strengthened.
THE CHANGED SCENARIO IN INDIA
Today, India’s GDP is almost 10 times higher than in 2001. India is the 5th largest economy. Capital is no longer as scarce. India holds the fourth-largest forex reserves globally. With a savings rate of 30.7%, India ranks fourth globally, while investment at 30.5% of GDP makes it the second-highest among large economies.
Indian firms are also investing abroad. RBI data shows outward FDI surged to $29.2 billion from $16.7 billion in the last fiscal, a 75% increase. Should this be considered a weakness? While it may put pressure on the rupee, it also reflects a strengthening economy.
On the export front as well, India has remained resilient. Total exports of goods and services were about USD 209.0 billion in Q1 FY26 and USD 209.9 billion in Q2 FY26, both record quarterly levels. First-half exports stood at USD 418.9 billion.
THE CHANGED GLOBAL SCENARIO
The US is returning to protectionism, similar to the 1930s. Many other countries have responded with retaliation. Wars and rising inflation have added to global uncertainty. Protectionism is often a sign of economic stress.
The US and several European economies are focusing on domestic investment to revive employment and growth. FDI inflows into India have slowed, largely due to weaker conditions in developed economies. Higher inflation is also reshaping interest rate differentials between countries, enabling carry trade opportunities as gaps widen.
Interestingly, the yield gap between Indian and US 10-year bonds has shrunk to around 2.5%, compared to a historical average of 4%. Post-COVID inflation in the US rose to 9%, forcing aggressive rate hikes. This narrowed the interest rate differential between India and the US, triggering capital outflows and putting pressure on the rupee.
Such rupee weakening, therefore, cannot be seen purely as a sign of domestic weakness. Once again, a narrowing interest rate differential has led to capital outflows and currency depreciation, but not because of underlying problems in India.
As Gita Gopinath has noted in the context of currency movements, a currency’s level matters less when growth, investment, inflation, and external stability are reasonably strong.
(Disclaimer: The article has been authored by Dr VP Singh, PGPM Director, Economics, Great Lakes Institute of Management, Gurgaon. Views expressed are personal.)