Tumbling Indian Rupee against USD

Dr R K Chadha

Discussions these days invariably converge on the free fall of the Indian rupee (INR) that breached 90 marks against 1 USD in 2025. While India’s real GDP grew by a strong 8.2% in the second quarter (Q2) of the fiscal year 2025-26 (July-September 2025), the INR depreciated against the USD from 85+ to 90+ during January-December 2025, a 5% fall.  What is this fall? First, let us understand the dynamics of currency exchange.

The United States Dollar (USD) is the dominant currency of world trade since World War II when 44 Allied Nations pegged their currencies to the dollar, which was convertible to gold, establishing a new global monetary system. Since then, the USD maintained its dominance due to its strong economy, stable financial markets, and its use in pricing key commodities like oil, cementing its role in international trade and finance.  Most of the countries keep their reserve currency in USD by purchasing US Treasury Bonds.

So, think of the USD like any other commodity in a floating system, whose value depends on market forces of demand and supply. The greater the demand, the higher the price, and vice versa.  Thus, the currency exchange rate of a country depends on the demand of USD and is influenced by factors like trade balance (export-import), economic performance, interest rates, inflation, and political stability.

Now, look at the Indian scenario.  India has been a Current Account Deficit country (CAD) for most of its history since independence, driven by increasing demands for crude oil, gold, defence equipment, electronic and other commercial goods, and factors like political instability and corruption.  A CAD country is one whose imports are greater than exports, that is, the country is spending more than the amount it is earning.  This has led to the 1991 Balance of Payments crisis, where India had to pledge its gold reserves to banks in the UK, Japan, and Switzerland.  The IT boom during the 1990s and the opening up of the Indian markets to foreign investments helped in partially offsetting this trend due to strong services exports and remittances. Though the situation has seen fluctuation, recent improvements with periods of moderate deficits and even occasional surpluses have been noticed, especially in the last decade.

The present-day weakening of the Indian Rupee by 5-6 % in 2025 is the result of several global factors like trade tensions due to Trumpian antics of tariff blackmail of 50% and sanctions, rush for buying gold by China, conflicts like Ukraine-Russia, Iran-Israel, US-Iran-Venezuela, and uncertainty in global political alignments due to Trump’s threat of annexation of Greenland and Canada.  All these factors are impacting the supply chain of crude oil on which India heavily depends. Foreign investors have fled Indian equities in 2025 at a scale never seen before, pulling out a record Rs 1.6 lakh crore (USD 18 billion) due to currency volatility.

To me, this looks to be a phenomenon of “Overshooting” that happens when incidents outside of structural equations governing trade and capital result in abnormal strengthening or weakening of currencies. Overshooting explains the sudden jump of exchange rates over a long-term equilibrium trend, due to sudden and shock events in monetary policy.  It tells us how financial markets adjust instantly while goods prices take a long time. The exchange rate initially overreacts, depreciating more than its long-run level, then gradually appreciates back as prices eventually catch up, leading to significant short-term currency volatility. I hope things will normalise after Trump’s madness ends.

My gut feeling is that the Reserve Bank of India is constantly watching the fall of INR and has an overshoot target in mind at which point it would intervene to bring down the rupee-dollar rate. This number could be anything between 90 to 95 or slightly more.  The RBI intervention most likely will hold INR between 91-94 rupees to a USD for one or two years or even strengthen to a more realistic value of 85 INR to a USD if Trump loses the midterms in November 2026 or when a new US President takes over in 2029.

Such interventions by RBI have happened in the past, the last being in 2013 when RBI Governor Raghu Ram Rajan introduced a very intuitive Foreign Currency Non-Resident (FCNR) swap scheme to raise USD 34 billion to stave off a collapse of INR in September 2013.  His intervention got the INR back to 61 from 70 for 1 USD within a few months.

In every crisis lies an opportunity, provided somebody takes the initiative.  Prime Minister Narendra Modi is leading from the front to reduce India’s dependence on USD and promote INR’s international use by signing bilateral trade agreements where trade can be done in Indian Rupee.  The Reserve Bank of India (RBI) has introduced SRVA (Special Rupee Vostro Account), where a foreign bank opens an account with an Indian bank in INR to manage payments for exports and imports with India. Indian importers pay into the SRVA, and exporters receive payments from it, while surplus funds can be invested in Indian government securities.

At present Russia, Sri Lanka, Mauritius, Bangladesh, Myanmar, Oman, and Tanzania are actively trading with India using the Indian Rupee and their local currencies through SRVA.  RBI has already given approvals and authorised banks of 22 countries to open SVRAs, allowing them to settle payments in INR.  These countries include Belarus, Botswana, Fiji, Germany, Guyana, Israel, Kazakhstan, Kenya, Malaysia, Maldives, New Zealand, Singapore, UAE, Uganda, and the United Kingdom (UK).

These initiatives support my argument that the US-induced free fall of the Indian Rupee is temporary and will end soon with Trump’s tenure, and will go back to the value dictated by the market forces of demand and supply. India is fortunate to have a visionary leader like Narendra Modi, who has kept the inflation low in the country despite the free fall of the Indian rupee in such global turmoil.  India’s inflation rate (CPI) was 1.33% in December 2025, a rise from November’s 0.71%, driven primarily by increased vegetable, meat, pulses, and spice prices, though overall it’s a low figure compared to previous years, with food inflation remaining negative at -2.71% for December 2025.

It is important to note that a little inflation, around 2-3%, is good for a country’s GDP growth because it encourages spending and investment as money loses value, so spend now. It also reduces the real burden of debt and helps wages adjust downward in “real” terms without cutting nominal pay, preventing economic stagnation and deflation, which is far worse for growth. It keeps money circulating, stimulates demand, and helps utilise idle resources, driving production and job creation.

I will end on an optimistic note that the free fall of the Indian rupee has a negligible effect on India’s economic growth as India’s GDP is being driven largely by domestic consumption and Government investments and not through growth in exports. But the future for exports is bright with the Make in India initiative that will promote exports and will further add to economic growth. Even the share market in India is driven by domestic investors and not by foreigners, indicating people have lot of money for investment.

Team Narendra Modi, keep up the good work.  Mr. Prime Minister, you have gone above and beyond.