The sudden decline in the value of the rupee has somewhat shaken the people and the markets. They wonder why this is happening when the economy is doing well, characterised by a good growth rate, low inflation, and a modest current account deficit.
India’s growth rate in the current year is estimated at 7.4%. Inflation has been subdued with CPI inflation ending the year 2025 at 1.33%, below the Reserve Bank of India (RBI)’s lower target band for the fourth consecutive month. The current account deficit as a percentage of GDP in the first half of 2025-26 is only 0.76 compared to 1.35 in the previous year. The fall in the value of rupee since April 2025 is about 6%.
The villain of the piece
Since the trade deficit (merchandise and services), which was $96.58 billion in April-December 2025 compared to $88.43 billion in the same period last year, is not that large, the main villain in the piece is capital outflows. There has been a steady outflow of capital since U.S. President Donald Trump took an adverse view on India and imposed 50% import duty on Indian exports. Initially, the U.S. imposed a 25% tariff on ‘reciprocal’ basis and then another 25% because India was importing crude oil from Russia. Now, it is threatening to impose an additional 25% tariff on countries that are doing business with Iran. This includes India, although trade with Iran is only 0.15% of the country’s total trade.
Net capital inflows in April-December 2024 were $10,615 million. In the same period in 2025, they turned negative, with a net outflow of $3,900 million. Despite months of negotiations with the U.S., no agreement has been reached yet. There seem to have been issues that could not be resolved easily. If this stalemate continues, the rupee will continue to fall.
We have to note that in the changed context, capital outflows are caused not by strict economic factors but by fears generated by the ‘hostile’ attitude of the U.S. In 2022, the rupee depreciated by almost 10%. That had some economic explanation, such as the Federal Reserve’s sharp hikes in interest rates. But this time, there is no clear economic explanation. Thus, the situation has shifted from the economic arena to the diplomatic platform. When tariffs are getting weaponised for geopolitical reasons, diplomacy is the major route for a solution.
RBI intervention
India’s exchange rate regime underwent a change in 1993 when it moved to a market-determined exchange rate regime. But the new system did not rule out the RBI’s intervention in the foreign exchange market. Since 1993, all RBI Governors have made it clear that the intention is not to use intervention to peg the value of the rupee, but to reduce its volatility.
However, the word ‘volatility’ was never defined. We can deduce from the actions of the RBI that reducing volatility means not only reducing fluctuations around a prevailing level, but also ‘moderating’ the fall in the value of the rupee when it happens. Shocks from rupee fluctuations have a cost. It is only to minimise the impact of such sudden shocks that there is intervention. Even then, it is not the intention of the RBI to prevent the fall, but to let it slide smoothly to whatever level it has to fall. It may be best for the RBI to clarify that reducing volatility also includes moderating the fall in the value of the rupee. After all, intervention, especially if it is asymmetric, does affect the level of exchange rate while minimising its volatility. The present situation adds another element — non-economic pressures acting on the value of the rupee. In fact, if India and the U.S. come to an understanding, the rupee will appreciate.
Why devaluation is not the remedy
Will a fall in the value of the rupee have any beneficial effects? The import content of India’s exports is rising. As a result, the stimulus to exports provided by devaluation will be moderated in the changed context. Further, given the high tariffs in the U.S. market, India’s exporters are unlikely to gain significant access there. On the import side, most of India’s imports are essential goods, with crude oil alone accounting for about 25% of total merchandise imports. A fall in the rupee would raise their prices, fuelling inflation.
India’s inflation is not higher than the inflation in developed countries in the West. Devaluation is called for when there is wide disparity in inflation. That is when we need to focus on Real Effective Exchange Rate (weighted average of a country’s currency relative to a basket of major trading partners, adjusted for inflation). It is true that some countries such as China have tried to keep the value of the currency undervalued. But this is currency manipulation, which is controversial.
The fall in the value of the rupee in the last one month has been caused by the fears engendered by the imposition of 50% tariff on Indian exports by the U.S. There is a possibility that the tariffs may even go up because of new legislation in the U.S. The full impact of the tariffs will be felt only in 2026-27.
What is hitting the rupee as of now are capital outflows. These outflows will continue to take place until India and the U.S. come to an understanding. We cannot ignore the fall in the value of the rupee. Capital outflows will get accelerated with every fall in the value of the rupee. The required earning in rupee terms will rise to attract investors in such a situation. When capital outflows happen because of the sale of stocks, they have a direct impact on the stock market. Our trade negotiators must reach an early understanding with the U.S. Meanwhile, the RBI can only smoothen the fall in the value of the rupee.
C. Rangarajan, Former Governor, Reserve Bank of India; N.R. Bhanumurthy, Director, Madras School of Economics, Chennai
Published – January 28, 2026 01:18 am IST
Source: https://www.thehindu.com/opinion/lead/the-solution-to-the-falling-rupee-lies-in-diplomacy/article70556822.ece
