Indian rupee enters 2026 on the back foot after worst annual drop in three years

The Indian rupee is poised for its largest annual fall in three years, weighed down by record equity outflows and the lack of a U.S. trade deal that left ​it out of the rally across Asia, with prospects for a recovery tied to the trade pact.

The rupee was ‌quoting at 89.8650 per U.S. dollar at 10 a.m. IST on Wednesday, marking a ⁠4.74% decline for the year, its worst showing ‌since 2022 when it dropped nearly 10%.

The currency repeatedly fell to record lows during the year, slipping past the 91 level at one point, highlighting the sustained depreciation pressure.

"The rupee's performance this year was largely a capital-flow story, with the RBI adopting a more pragmatic and flexible approach to the exchange rate and allowing the currency to weaken," said Gaura Sen Gupta, an economist at IDFC ​First Bank.

India's balance of payments slipping into a roughly $22 billion deficit between April and November, the largest historically, indicates the external strains facing the economy, Sen Gupta said.

A trade deal with the U.S. could offer temporary relief, potentially lifting the rupee to around 88.50 by March, before underlying pressures reassert themselves and the currency weakens ‌again, she said.

A ‌Reuters poll broadly aligns with that view.

A DIFFERENT STORY FOR THE RUPEE

The rupee’s rough patch stands in marked contrast to its rout in 2022, when aggressive rate hikes ⁠by the U.S. Federal Reserve fuelled a broad rally in the dollar.

In 2025, the backdrop was very different with the dollar index down about 9.5% on Federal Reserve rate cuts and restrictive U.S. trade policy, which supported most Asian currencies.

The rupee's underperformance relative to its peers was largely a function of heavy ⁠equity outflows and slowing capital inflows elsewhere, economists said.

Foreign investors withdrew a record $18 billion from ⁠Indian equities in 2025, while debt, external commercial borrowing and foreign direct investment flows were subdued.

Prolonged ‌negotiations with the U.S. further compounded the capital flow challenge by reducing predictability around India’s trade outlook.

U.S. policy ‌uncertainty dulled appetite for the rupee, setting it apart from Asian peers that faced less tariff-related pressure.

SHIFT IN RBI'S APPROACH

The Reserve Bank of India's approach to rupee swings saw a change after Sanjay Malhotra became governor in December 2024.

Under Malhotra, the RBI has ‍become more tolerant of currency weakness, with its market interventions primarily aimed at managing depreciation expectations and countering the buildup of one-sided speculative positions, bankers said.

This change was most evident in mid-December, when the rupee fell past the 91-per-dollar mark for the first time. The RBI intervened heavily to rein in speculative pressures while not defending a specific level, bankers said.

The rupee's decline in 2025 alongside the rally in other currencies means the rupee is no longer overvalued.

India’s 40-currency trade-weighted real effective exchange rate declined to 97.5 in November from 104.7 in January 2025, according to central bank data. A reading above 100 indicates that a currency is overvalued, while a level below ​100 suggests it is undervalued.

Dhiraj Nim, an economist ‌and FX strategist at ANZ Bank, said that considering the steep U.S. tariffs, a calibrated path, tilted towards a mildly undervalued rupee over the medium term, will help exporters.

"A weaker INR can cushion the local currency earnings of an impacted Indian exporter, providing relief."