External headwinds batter rupee despite strong fundamentals

The Indian rupee has come under intense pressure, emerging as one of the worst-performing currencies in FY2026, with a depreciation of 10.8%, its steepest fall since 2012. While the ongoing West Asia conflict has accelerated the slide, the currency had already been weakening in the months leading up to the crisis, even as several global peers held firm.

A mix of global and domestic factors contributed to the early decline. Uncertainty around US trade tariffs, slowing export momentum, sustained foreign portfolio investor (FPI) outflows, a widening trade deficit and elevated gold imports all weighed on the rupee. The Reserve Bank of India’s (RBI) calibrated approach to depreciation also played a role in allowing gradual adjustments.

However, the situation worsened significantly after the outbreak of hostilities involving Israel, the United States and Iran on February 28. Disruptions in the Middle East, particularly in oil, gas and fertiliser supply chains, along with logistical challenges such as shipping constraints, pushed the rupee to levels that were neither expected nor anticipated. The currency briefly breached the Rs95 per US dollar mark before settling around Rs94.70, marking a 4.5% decline since the conflict began.

The RBI earlier has put curbs on commercial banks to restrict the bank's net open positions in the domestic market at $100 million. This step has been taken by RBI to have additional availability of dollars in the market which helped rupee opened 128 basis points higher at 93.57 per dollar on Monday morning as against the all time low of 94.85 per dollar on Friday, however the gains could not be sustained for long as the rupee settling around the same level of 94.70 per dollar at the end of the day, after briefly breaching the level of 95 per dollar. The banks are not happy with the RBI’s directive and requested the central bank to reconsider the guidelines.

A major driver of the rupee’s weakness has been the sharp surge in global crude prices. Brent crude has risen more than 60% since the conflict began, hovering around $115 per barrel. Concerns over disruptions in the Strait of Hormuz, a critical artery for over 20% of global oil supplies, have heightened fears of a prolonged energy crisis. For an import-dependent country like India, higher oil prices translate into increased pressure on the balance of payments, rising import bills and a widening current account deficit.

Economists warn that if elevated energy prices persist, India’s current account deficit could widen to $35 billion in FY26 and further to $40 billion in FY27. Although the country’s foreign exchange reserves remain robust at over $700 billion, the RBI may not be able to rely solely on intervention to stabilise the currency and could be forced to deploy a mix of policy tools to manage volatility.

Despite the sharp depreciation, Finance Minister Nirmala Sitharaman has struck a note of confidence, asserting that the rupee is “doing fine” when viewed against other emerging market currencies. She emphasised that India’s economic fundamentals remain strong, supported by steady growth, prudent fiscal management and healthy foreign exchange reserves.

Indeed, India’s macroeconomic position is considerably stronger than during the 2013 ‘Taper Tantrum’, when the country faced severe external vulnerabilities. Today, with GDP growth above 7%, a fiscal deficit below 4.4% of GDP and forex reserves sufficient to cover nearly 11 months of imports, the economy is better equipped to withstand external shocks.

However, financial markets have not been immune to the turbulence. Equity benchmarks have posted notable declines, with the Nifty 50 falling 5% and the Sensex dropping 7% in FY26. Since the onset of the conflict, the Nifty has slipped over 11%, reflecting investor caution amid global uncertainty and persistent capital outflows.

On the domestic front, there are signs of resilience. Industrial activity remains steady, with the Index of Industrial Production (IIP) expanding 5.2% in February, driven by strong performance in manufacturing and capital goods. Yet, economists caution that prolonged geopolitical tensions could disrupt supply chains and weigh on production in the coming months.

With inflation under control, the fiscal deficit below 4.4% of GDP, and the current account deficit well contained, India’s macroeconomic fundamentals remain strong. GDP growth continues to outpace most global peers at over 7%, while foreign exchange reserves stand at around $700 billion—sufficient to cover nearly 11 months of imports. This position is significantly stronger than in 2013 during the taper tantrum, when the rupee depreciated sharply following signals from the US Federal Reserve to scale back its bond-buying programme. At that time, India’s weaker fundamentals, forex reserves of about $300 billion and a current account deficit of around 5% of GDP, placed it among the so-called “fragile five” emerging economies. Elevated oil prices, then hovering near $100 per barrel, further exacerbated the situation.

Since then, a sustained decline in oil prices has helped improve the current account balance, alongside strong foreign investments, robust NRI remittances, and steady export performance. With the current account deficit at around 1% of GDP (until December) and forex reserves at $700 billion, India’s position is considerably stronger today. The government has also reduced the fiscal deficit from elevated COVID-19 levels to about 4.4% of GDP. Despite global headwinds, geopolitical tensions, and trade uncertainties, India has managed its economy effectively, with prudent monetary policy by the RBI helping bring inflation down to below 2%. Growth is projected at 7–7.4% for the current financial year. While the macroeconomic outlook remains solid, emerging geopolitical risks pose challenges. To sustain momentum, India must pursue the next phase of reforms, strengthen domestic growth drivers, boost both public and private investment, and prioritise innovation, research, and technology. Enhancing services and manufacturing exports, along with leveraging recently signed FTAs for trade diversification, will be crucial to maintaining long-term growth resilience

Looking ahead, the trajectory of the rupee will largely depend on how the geopolitical situation evolves, along with trends in oil prices, capital flows and policy responses from the RBI. Experts warn that sustained high energy costs and potential spikes in food inflation could push inflation beyond the 4% target, raising the possibility of interest rate hikes later in the year.

While India’s strong fundamentals provide a buffer, the current environment presents a complex challenge. Policymakers will need to carefully balance growth and stability as the economy navigates a period marked by heightened global uncertainty and external shocks.

The rupee is currently under intense pressure, having hit record lows of around Rs93–95 per dollar in March 2026. The decline has been driven by massive Foreign Portfolio Investor (FPI) outflows exceeding Rs1.18 lakh crore, rising oil prices amid West Asia conflicts, and a strong dollar.

Going forward, if geopolitical tensions persist, the rupee is expected to remain volatile. Its trajectory will largely depend on global developments, management of the trade deficit, and the RBI’s use of various tools to curb excessive volatility.

The April RBI monetary policy will provide further clarity on the central bank’s future course of action, particularly in balancing inflation management with growth support.

(The author is former Chairman & Managing Director of Indian Overseas Bank)