By Sanjay Roy
The rupee has further depreciated vis-à-vis the dollar reaching 95.87 against the US dollar on June 15. It appears like a free fall and the weakening of the rupee by itself is nothing, but an indicator of how India’s economic health is perceived by foreign investors. The balance of payments, that is India’s transactions with the world, are composed of two accounts namely the current account and the capital account. The current account shows mainly the export and import values, that is how much as a country we are selling to the world and how much we are buying from the producers of the world. It also includes earnings from Indian companies abroad and interest payments made against loans by Indians.
The current account also includes remittances of NRIs and outflows by foreigners residing in India. But trade in goods and services is the biggest component of current account. Since international transactions can only happen in a global reserve currency, that is the dollar, we earn dollars through exports that can be used to fund our imports. The US has the advantage of maintaining huge current account deficits because the global currency is their home currency and they can print money anytime to balance their current account and do not have to earn dollars through exporting.
India usually has a current account deficit, that is we spend more dollars in importing than what we earn through our exports. The respite has been provided by the capital account surpluses that provided additional dollars over and above what we earn through trade. The capital account includes inflow and outflow of FDI, which are supposed to be longer term investments, and FPI or foreign portfolio investment, which are usually volatile as they are primarily speculative capital invested in financial markets. If capital account surpluses offset the trade deficits or deficits in the current account the rupee remains stable vis-à-vis dollar. But if the deficit in the current account cannot be bridged by the surpluses in capital account, it means we do not have enough dollars to serve our imports or foreign debts. As a result, demand for dollars increases with respect to rupees causing depreciation of the rupee. The current context of rupee fall is because of losing surpluses in the capital account, which is creating pressure on rupee.
Exchange rate depreciation is a combination of several factors of which some relate to short term fluctuations while the larger context is about increasing domestic savings, export competitiveness based on innovation and productivity and stable net inflow of FDI. The current account deficit may not lead to currency depreciation always as surpluses in capital account may hold the rupee stable. The depreciation in the case of India is a result of widening merchandise deficit. While this was compensated partially by surpluses in services exports in the recent past, it was accompanied by rising outflows of capital particularly FPI and outward FDI. FDI inflows declined in the recent past.
The flows of FPI primarily depend upon investor sentiment, which depends on both internal and external factors. Increased uncertainty in global trade and deliberate dismantling of global trade norms have increased risks in investment. In the context of high risks, capital flows towards assets assumed to be relatively stable and hence outflows towards advanced economies increase. Also rising interest rate in advanced economies have attracted capital flows towards these economies.
It is important that India’s exports grew faster in the recent period, but the growth of imports had been even higher, thus widening the merchandise trade deficit. Although there are some changes in the composition of our exports, it largely remained traditional in nature. On the other hand, import intensity of exports have increased with rising participation in global value chains together with energy dependence, which contributed to rising import bills. It is important to note that capital account surpluses declined not only because of outflow of portfolio investments but also of declining inward FDI. Government policies being biased towards one or two business houses increasingly raise doubts on stability of returns for both domestic and foreign investors.
The rupee fall cannot be entirely attributed to the US-Iran war and the disruption of supply chains. In fact, from April 2025 to January 2026, the rupee depreciated by 5.4 per cent and it was recorded as the highest depreciation in the world during that time. During the same time, currency depreciation was much lower in many developing countries and it even appreciated in the case of Brazil or South Africa. Therefore, it is not only about short-term remedies but to maintain stable exchange rate it is important that India builds her capabilities of exports based on innovation and rising productivity rather than relying on cheap labour. Rhetoric and symbolism of Atmanirbhar Bharat could not reduce our import intensity in production. Make in India and PLI schemes didn’t help increasing our share in global manufacturing. Also, India could not attract enough investment in growing sectors such as energy transition, Artificial Intelligence and digital transformation because other economies are far ahead of India in these regards.
There is an attempt to trivialise the depreciation of the rupee, which is in a free fall and might be reaching hundred per dollar. The market led correction theory primarily says that as the rupee falls exporters would gain as Indian products become cheaper in the world market and that would bring us more dollars. On the other hand, as the rupee falls imports become costlier and therefore imports will be naturally restricted reducing the outflow of dollars. But these tendencies depend on how external markets respond to price changes and if Indian producers are very much dependent upon imports as in the case of energy and other components and machinery, the corrective adjustment may not work.
Also, the depreciation of the rupee would additionally increase prices of oil and other imported products because of the depreciated currency apart from the direct rise in dollar terms. Most importantly, as prices of oil, fertiliser and other inputs increase, it would adversely affect food prices and all raw materials transported creating cascading effects on general price levels. Such a price increase in consumer goods and particularly food is going to asymmetrically affect the poor because they have a larger share of income spent on consumption than the rich. The RBI has intervened in the currency market by running down forex reserves primarily to arrest the free fall.
The long-term issues related to exchange rate depreciation need corrective measures towards changing the composition of exports, restricting import intensity in production, stimulating innovation and technology related sectors and garnering investment, domestic or foreign. Traditional products still dominate our exports, which may not be very price sensitive. On the other hand, import dependence of industrial production increased significantly in the recent past. It indicates that India is confined to low value-added production as the larger share of output comprises of imported components.
The other important thing is declining growth of private investment. If domestic investors become hesitant to invest in India and invest outwards, there is hardly any possibility of large FDI inflows. Investors also tend to flock towards high premium sectors which are often related to new technology. Also, there are clear tendencies towards favouring one or two business houses, which creates disincentive for others. It is not the case that the Iran-US war is going to be resolved permanently soon. Rather such lingering conflicts in West Asia seem to be continuing for some time more. The economy will face similar disruptions in the coming days and therefore it is better to focus on long term structural issues. (IPA Service)
