A weaker rupee does not signal a weak economy
Currency depreciation creates short-term headwinds that can be tackled with a focus on strategic reforms
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Prefer us on GoogleLast Updated: Dec 10, 2025, 11:45 IST3 min
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The weakness in the Indian rupee has recently attracted a lot of market attention. Indeed, the currency has weakened the most against the US dollar among major Asia-Pacific currencies this year. While this FX weakness reflects capital outflow pressures, it is not necessarily a sign of a weak economy.
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Exchange rates are determined only in international transactions of an economy, where more selling of the currency weakens the exchange rate. This is why FX weakness happens even if domestic economic activity is resilient.
Why the rupee is falling
The Indian rupee is weakening on the back of net capital outflows—investors selling portfolio holdings such as equities and converting rupee proceeds into foreign currency. This selling pressure outweighs demand from buyers investing in India or converting export proceeds resulting in a weakening of the currency.One potential factor driving the weaker rupee is investor anxiety on ongoing trade frictions with the US. Another potential reason is weaker investor confidence in expected returns on investment. These key drivers are confidence-based factors that do not necessarily reflect the state of the economy.
Also Read: Rupee breaches 89-per-dollar mark, may stay under pressure
Short-term challenges
A weaker rupee does create short-term headwinds. Imports become more expensive. Manufacturers and firms relying on imported inputs or providing imported goods and services for consumers face higher costs. Tourism abroad becomes more expensive, as does remitting money abroad.Given India’s status as a net energy importer—with crude oil and gas representing critical imports—energy bills can rise significantly when the exchange rate weakens.
Consumers in India have a strong preference for gold purchases, and as such gold is a large commodity import that becomes more expensive.
But not all bad news
On the other hand, a weaker exchange rate benefits exporters. Export prices are typically denominated in US dollars, but fixed costs and labour costs would be in Indian rupees. A weaker rupee means lower costs in USD terms and profit margins rise.Over a medium horizon, a weaker currency can boost competitiveness by lowering the local cost base in an international comparison. This can attract investment as firms search for cost-efficient locations for producing goods and services. To take advantage of this, the economy’s ease of doing business and attractiveness to investment must be in place.
Weakening trend likely to continue
While the trade and geopolitical environment remains uncertain, there is likely to be sustained capital outflow pressure on the INR. High US tariffs dampen FDI momentum into the economy as well. The rupee is likely to remain on weaker footing in the near term.On the other hand, successful conclusion of trade negotiations with the US could support the rupee. Trade-related uncertainty would then be lower and may prompt capital inflows. Sustained strong growth momentum can also provide some cushion against FX outflows, as investment into the economy becomes more attractive.
RBI’s balancing act
The Reserve Bank of India (RBI) has the tools to intervene in foreign exchange markets by selling reserves to bolster the rupee. However, it has recently adopted a more measured approach, because using reserves to defend the currency is a costly and often inefficient strategy. This type of intervention depletes reserves without addressing the underlying causes.Instead, the primary use for reserves is to provide resilience in balance of payments and international financing, and to smooth sharp FX fluctuations.
Building resilience
Navigating this currency environment effectively requires a focus on strategic reforms. Increased capital mobility and access to financial markets for international investors can help deepen financial markets and make currency markets more resilient.Crucially, addressing India’s significant energy import dependence—which accounts for roughly 30 percent of the total import bill—is essential. Two important reforms in this area can help.
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First, a gradual reduction of energy subsidies is key. When global energy prices rise, or when the INR exchange rate weakens, energy import bills go up but, because of subsidies, energy demand does not drop. This means there is inefficiently high energy usage in these times.
Second, alongside gradual reduction of energy subsidies, there should be further investment in energy security. There is already a push for greater energy security, and continued investment in alternative energy, such as renewables and nuclear power, is vital to reduce reliance on imported fuels.
Sentiment, not fundamentals
While the recent depreciation of the rupee presents near-term headwinds for Indian importers and consumers, it doesn't inherently signal weakness in the underlying economy. External factors and investor sentiment are driving the current FX pressure. Together with the RBI’s prudent approach, measures such as open financial markets, reduced energy subsidies, and greater energy security can increase foreign exchange resilience.The author is senior economist, S&P Global Ratings
First Published: Dec 10, 2025, 11:59
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