Rupee In Freefall Spotlights Structural Imbalances

What began as a market reaction to the US–Iran conflict and surging oil prices has now evolved into a broader crisis involving trade imbalances, speculative capital flows, weakening foreign investment and mounting pressure on India’s balance of payments.

The rupee, which traded near ₹90 against the dollar in January, touched an all-time low of around ₹96.8 this week, marking a depreciation of more than 7% in less than five months. Since the disruption of shipping routes through the Strait of Hormuz in early March, the currency has lost over 5%, placing it among the weakest-performing emerging market currencies in 2026.

India’s Exposure To Global Energy Volatility 

The fall reflects India’s acute exposure to global energy volatility. India imports nearly 85% of its crude oil requirements, with petroleum accounting for roughly 22% of total imports. Brent crude prices hovering around US$107–110 per barrel have sharply inflated India’s import bill, widening the trade deficit and increasing demand for dollars across the economy.

India’s merchandise trade deficit widened to nearly $333 billion in FY2025-26, while the trade gap with China alone reached approximately US$112 billion. Simultaneously, Foreign Portfolio Investors have withdrawn an estimated US$17–19 billion from Indian equity markets this year amid global uncertainty and higher US interest rates.

Analysts at Capital Economics say India’s current account deficit could widen from around 0.3% of Gross Domestic Product (GDP) earlier to nearly 1.8% this year. The consultancy warned that although India’s external debt burden remains manageable, prolonged oil shocks and weaker capital inflows could keep sustained pressure on the rupee.

Yet the current crisis is no longer being explained purely through trade and oil fundamentals. Economists increasingly argue that speculative positioning and sentiment-driven trading are amplifying volatility.

Economists at the Bank of Baroda observed that the rupee is being “tested one rupee at a time,” with each breached level — ₹94, ₹95, and ₹96 — quickly becoming the new trading floor. The bank’s analysis suggested that crude oil movements and lagged foreign portfolio flows explained barely one-fourth of the rupee’s recent volatility. The remaining movement, it argued, was driven largely by geopolitical sentiment, speculative momentum, and market psychology.

The annualised volatility in the rupee has climbed to around 6.7% during the March–May period, unusually elevated for a currency traditionally considered relatively stable among emerging markets.

Should RBI Defend The Rupee

This has intensified the policy debate over whether the Reserve Bank of India (RBI) should aggressively defend the rupee or allow markets to determine a new equilibrium.

Economists favouring limited intervention argue that exchange rate flexibility acts as a natural stabiliser during external shocks. Gita Gopinath, Former International Monetary Fund (IMF) First Deputy Managing Director, has argued that a weaker rupee can eventually reduce imports, improve export competitiveness and help rebalance the external account. Former NITI Aayog vice-chairman Arvind Panagariya similarly warned policymakers against allowing “psychological thresholds” such as ₹100 per dollar to dominate policy decisions.

Capital Economics assesses that a 10%-rupee depreciation would add only about 0.5 percentage points to inflation over three to four quarters. The RBI’s India’s earlier estimates also suggested that a 5%-depreciation could add nearly 0.25 percentage points to GDP growth through improved export competitiveness.

However, critics argue that the current depreciation is not a stable adjustment but a destabilising currency slide. O.P. Jindal Global University's Rahul Menon has argued that policymakers are overlooking the difference between a weak currency and a falling currency. According to Menon, while a stable undervalued currency can support exports, a rapidly depreciating currency creates uncertainty that discourages trade settlements and investment decisions.

Menon argues that importers accelerate hedging activity when depreciation intensifies, while exporters often delay converting export earnings in anticipation of further rupee weakness. At the same time, demand for essential imports such as crude oil remains highly price inelastic in the short term, limiting the corrective impact of depreciation on the trade balance.

The speculative dimension has complicated RBI intervention efforts. The central bank is estimated to have spent nearly US$ 12 billion defending the rupee during the first phase of the Iran conflict alone. Its forward intervention book reportedly expanded from around US$ 68 billion in January to nearly US$ 100 billion by May.

Risks Of Intervention 

Intervention carries risks of its own. Sustained reserve depletion could weaken investor confidence, while insufficient intervention may fail to arrest speculative momentum. Japan’s struggle to stabilise the yen despite repeated intervention warnings has highlighted the difficulty central banks face when confronting global dollar strength and momentum-driven currency trades.

The rupee’s depreciation is also intensifying India’s domestic fiscal pressures. SBI Research warned that the currency has approached a “critical depreciation threshold.”

According to SBI calculations, assuming crude oil prices near US$ 106 per barrel and an exchange rate of ₹94 per dollar, the landed cost of crude oil has already risen to almost ₹9,964 per barrel. Although the recent ₹3-per-litre fuel price increase provided Oil Marketing Companies a benefit of roughly ₹477 per barrel, according to SBI, a further depreciation of just ₹2 would increase crude costs by nearly ₹410 per barrel, effectively wiping out most of the gains from the fuel hike.

Oil Marketing Companies are believed to be losing close to ₹1,000 crore per day despite retail fuel price increases. The Centre had already reduced excise duties by around ₹10 per litre in March at a fiscal cost of nearly ₹1.1 lakh crore. A full excise rollback could widen the fiscal deficit by nearly 0.5% of GDP while sharply reducing state VAT revenues.

SBI Research also observed that the correlation between crude oil volatility and rupee volatility has risen to 0.53 since the escalation of the Iran conflict, indicating that India’s energy and currency crises are increasingly reinforcing one another.

Is India’s Growth Model Sustainable?

The crisis is also reopening questions about the sustainability of India’s broader growth model. Over the last decade, India has relied heavily on services exports, remittances and foreign capital inflows to finance rising imports and domestic consumption. That framework functioned during years of abundant global liquidity but appears increasingly fragile amid geopolitical fragmentation and tighter global financial conditions.

Ashwani Mahajan, co-convener of Swadeshi Jagran Manch, has argued that India’s widening trade deficit with China, declining net Foreign Direct Investment (FDI) inflows and rising outward remittances represent structural vulnerabilities rather than temporary pressures. Mahajan pointed out that net FDI inflows have fallen from nearly US$ 40.9 billion in 2014-15 to around US$ 10.2 billion last year, while outward payments through dividends, royalties, and interest generated net forex outflows of nearly $48.4 billion in FY2024-25.

At the same time, India’s dependence on overseas remittances has intensified. Annual remittance inflows are estimated at roughly US$ 140 billion, making them one of the largest and most stable sources of dollar inflows supporting India’s balance of payments.

Mahajan has advocated selective tariff barriers, tighter scrutiny of speculative capital, and stronger industrial policy measures to reduce import dependence. Critics argue that such measures may undermine investor confidence and integration into global supply chains. Yet even market-oriented economists acknowledge that India’s heavy dependence on imported energy, electronics, and industrial machinery remains a critical external vulnerability.

Comparison With Other Currencies

Compared with other major currencies, the rupee’s decline has been especially severe this year. The Japanese yen has weakened amid monetary policy divergence, but Japan continues to benefit from large external surpluses and deep reserves. China’s yuan has depreciated gradually under managed state control supported by export strength. The euro and pound have faced energy related pressures but retain reserve currency advantages and deeper financial markets.

India, by contrast, remains more exposed because of persistent current account deficits and high oil import dependence.

The rupee’s fall is also beginning to affect India’s geopolitical economic standing. India had briefly overtaken Japan to become the world’s fourth-largest economy in nominal dollar terms. However, the depreciation of the rupee has reportedly reduced India’s dollar-denominated GDP size, allowing Japan and the United Kingdom to regain higher positions in global rankings.

Deeper Concerns

Analysts at BMI Research expect the rupee to stabilise near ₹95 by year-end if oil prices moderate and RBI interventions continue. But the firm also warned that a prolonged escalation in West Asia or continued capital outflows could push the currency towards ₹100 per dollar.

The deeper concern for policymakers is that the rupee’s decline is increasingly being interpreted not as a temporary wartime dislocation, but as evidence of structural imbalances embedded within India’s external economic architecture.

India’s strengths — including services exports, pharmaceuticals, digital industries, and remittance inflows — remain substantial. But the present crisis has demonstrated that those strengths alone may not be sufficient to shield the economy from simultaneous shocks arising from energy markets, geopolitical tensions, and speculative capital movements.

The rupee’s trajectory over the coming quarters will therefore depend not only on oil prices or RBI intervention, but on whether India can fundamentally rebalance its growth model towards stronger manufacturing exports, lower import dependence, and more stable long-term capital formation.

(The writer is an economics analyst and journalist. Views expressed are personal.)