Rupee to grapple incessant volatility in 2026; US trade pact may not be silver bullet

The RBI, which sees the rupee's depreciation as a silver bullet to offset the tariff shock, expects the currency to find its stable course once India reaches a trade deal with its largest trading partner, the US.

New Delhi: The Indian rupee, swaying through multiple headwinds, tiding over global trade disruptions and massive foreign fund outflows, is unlikely to arrest its descent until tariff impact overhangs, notwithstanding robust domestic macroeconomic tailwinds.

The Reserve Bank of India (RBI), which sees the rupee's depreciation as a silver bullet to offset the tariff shock, expects the currency to find its stable course once India reaches a trade deal with its largest trading partner, the US.

The Indian currency has sunk nearly 5 per cent since the 85-per-dollar level in January and even breached the historic low of 91 against the greenback. During the year, the rupee's exchange rate has weakened over 19 per cent against the euro, around 14 per cent versus the British pound, and over 5 per cent with respect to the Japanese yen.

It performed worst among Asian peers, even as the American currency index slid beyond 10 per cent, and the international crude oil prices stayed weak.

A cataclysmic fall in the currency, beginning with the sweeping reciprocal tariffs announced by US President Donald Trump in April, propelled a relentless withdrawal of funds by foreign investors chasing better returns in other emerging markets.

The trend is reflected in the inflow of foreign funds through the foreign direct investment route. On a net basis, FDI between January and October this year turned negative.

Anindya Banerjee, Head of Currency & Commodity Research, Kotak Securities, explains: "FDI acts as the anchor flow for the balance of payments. When that anchor weakens, the currency becomes more dependent on portfolio flows; forex markets turn more sensitive to global risk sentiment; and central bank intervention requirements increase."

This seems to have accelerated the rupee's fall. It crashed more than 1 per cent in one session on November 21 to 89.66 against the greenback. Within 13 days, it breached the 90/dollar level on December 2, and crossed the historic low level of 91 versus the dollar on December 16.

The government attributed the slide to widening trade gap and the lack of progress in negotiations on a trade pact with the US amid weak capital account.

"...the depreciation of the INR has been influenced by the increase in trade deficit and likely prospects arising from the ongoing developments in India's trade agreement with the US, amid relatively weak support from the capital account," Minister of State for Finance Pankaj Chaudhary told the Rajya Sabha on December 16.

RBI Governor Sanjay Malhotra has said the central bank does not target any band for the rupee in the forex market.

Dilip Parmar, Research Analyst, HDFC Securities, sees "capital account crisis" as the primary reason for the rupee's fall. "Unlike previous crises driven by trade, the current slide is due to shrinking capital inflows", he said.

Besides, he said, the RBI implemented rate cuts to support domestic growth, making the rupee less attractive.

The RBI has moved towards a more flexible exchange rate, which the IMF terms as a "crawl-like" arrangement.

"Uncertainty over the India-US trade deal, along with the US imposing 50 per cent tariffs on exports from India, negatively impacted the rupee as it hampered India’s exports, leading to widening of trade deficit," says Anuj Choudhary, Research Analyst, Mirae Asset ShareKhan. He projects the rupee to decline towards 91 and 92.50 levels in the near term.

The rupee's challenges escalated with the depletion in net foreign investment inflows -- the overall investment that flowed in the country minus the total outflow.

A sharp decline in FDI has "reduced long-term dollar inflows, making the rupee more dependent on volatile portfolio flows", said Jateen Trivedi, VP Research Analyst, Commodity and Currency, LKP Securities.

"Higher commodity prices and elevated risk on US trade deals kept FDI away and impacted the rupee majority due to lack of intent in inflows and going elsewhere, which are our competitors," Trivedi added.

The RBI data shows that the total investment inflows turned negative at USD (-) 0.010 billion between January and October this year. In comparison, the country recorded an inflow of USD 23 billion during January-December of 2024.

Net foreign direct investment (FDI) during January-December 2025 stood at USD 6.567 billion, while the net portfolio investment stayed negative at USD (-) 6.575 billion.

The data for the July-September FY26 shows in terms of balance of payment, there was a depletion of USD 10.9 billion to the foreign exchange reserves against an accretion of USD 18.6 billion in the year-ago period.

Dilip Parmar of HDFC Securities says the current rupee crisis is being driven almost entirely by a capital account imbalance. The record USD 17.5-billion exit by FIIs in 2025 has created a massive demand for dollars, forcing the rupee down.

The current account deficit (CAD) is expected to widen to 2 per cent or more in 2026 as the full impact of US "penalty tariffs" hits Indian goods exports. This is expected to increase the structural demand for dollars. "A trade pact with the US would help, but it is not a silver bullet," said Banerjee of Kotak Securities.

According to him, faster and smoother FDI approvals, deepening domestic bond and forex markets, and reducing reliance on short-term portfolio flows are equally important.

Despite challenges, the rupee is expected to trade through extreme volatility, riding on strong macroeconomic fundamentals.

With a steady pace of growth and moderate inflation, India's macroeconomic factors provide a solid long-term anchor for its currency, echoes Banerjee, as he projects the rupee to "test 92–93 levels due to global volatility and transient risk-off phases" over the next three-four months.

However, from April onwards, "as global capital realigns toward stable growth economies and dollar weakness becomes more evident, the rupee is expected to enter a phase of appreciation, with levels of 83–84 by the end of FY27", Banerjee said.