By: Keya Vinay

Edited By: Amish Gupta

The Indian rupee emerged as Asia’s worst performing currency in 2025, depreciating against the U.S. dollar by approximately 5%, marking one of its steepest declines in recent years. This sharp depreciation was primarily caused by elevated U.S. interest rates, strong foreign institutional investor (FII) outflows and geopolitical pressures in the form of tariffs. Tariff uncertainty triggered the first significant period of volatility in April 2025 upon the announcement of reciprocal tariffs. The uncertainty surrounding the India-US trade deal in 2025 led to a widening of India’s trade deficit.  This, combined with the US imposition of 50% tariffs on India, was primarily responsible for increased FII outflows (exceeding $18 billion) in 2025. As one of the sharpest episodes of recent volatility, it shook market sentiments and led to a rise in questions pertaining to a potential structural weakness in India.

The Reserve Bank of India operates a managed floating exchange rate regime, with the primary focus of intervention being minimizing exchange rate fluctuation rather than currency control. Hence, the RBI is primarily concerned with maintaining a stable exchange rate rather than defending one specific exchange rate level. RBI’s primary intervention methods include spot market intervention, forward market operations and liquidity management. The RBI intervened across onshore spot markets to increase rupee supply and offshore non-deliverable forwards (NDFs) to influence pricing and control speculation before the opening of the domestic market. In FY25 up till October, the RBI’s cumulative net dollar sales stood at $34.5 billion. December 2025 reflected the 7th consecutive month of net dollar sales, with the net sale standing at $10.02 billion. The RBI relied on forward contracts for influencing future expectations without immediately using the reserves, and by Dec. 31, 2025, the size of the short FX forward book stood at $62.3 billion.

Under the RBI Governor Sanjay Malhotra, who assumed office in December 2024, the RBI’s strategy on the INR reflected a deliberate policy decision of adopting greater flexibility with the market-determined exchange rate and preserving domestic monetary policies. This contrasts RBI’s more aggressive intervention strategies, as was observed in previous years.

The last time the INR experienced a level of volatility compared to the levels seen so far in 2025-2026, was during the 2013 “Taper Tantrum”. The Taper Tantrum was the US Federal Reserve’s threat to taper quantitative easing, triggering massive foreign outflows from emerging markets, with India being one of the worst hit. The INR experienced severe depreciation of around 20% against the USD during this period between May 2013 to August 2013. India was particularly vulnerable during this time due to its high Current Account Deficit (CAD), which was 4.8% of its GDP. The RBI intervened heavily, announcing a special Foreign Currency Non-Resident (FCNR) Swap Window, offering a 3.5% fixed interest rate for three years to increase the inflow of USD into India and stabilize the INR. These swap windows brought in around $34 billion USD, with $26 billion arriving solely through the FCNR route. Hence, this scheme proved to be successful in the short run, however was criticised for being too interventionist and leading to reserve depletion. The primary difference between the RBI’s aggressive approach in 2013 and its crawling approach right now is that 2013 actively called for an emergency response, one that is unnecessary in the present context and would not be sustainable.

The INR volatility paved way for larger concerns regarding a potential structural weakness in the Indian economy; specifically regarding the persistent widening of the CAD, excessive dependency on foreign capital inflows and a lack of global export competitiveness. According to sources like The Hindu, critics argue that the manufacturing sector’s failure to occupy a meaningful role in global value chains makes the economy structurally import dependent and vulnerable to commodity price swings. Heavy dependence on FIIs for balance-of-payments support revealed vulnerabilities, highlighting a strong dependency on short-term volatile capital rather than a stable FDI or export-led growth.

These concerns regarding the Indian economy were heightened due to the INR volatility and sharp depreciation, however each of these concerns can be addressed. As per the PRS Legislative Research, India’s CAD in the first half of 2025-26 was 0.8% of the GDP, lower than the first half of 2024-25. Despite running a goods trade deficit, the CAD remains contained and is estimated to contain a fiscal deficit to below 4.5% of GDP in 2025-26 — this has been noted as a structural feature of a growing economy rather than a failure. Although FII outflows were strong in 2025, India’s FX reserves stayed strong and external debt remained low with FDI inflows in 2025 13% higher than the previous year. As of Jan. 16, 2026, FX reserves covered about 11 months of imports and 94% of the external outstanding debt. Expansion of higher-value manufacturing exports and diversification of export destinations have helped sustain exports, despite the impact of high tariffs from the USA. Economists also claim that the INR depreciation provides a competitive price advantage over trading partners for India.

In the present context, the RBI’s flexible approach is a better solution as India’s fundamentals in 2025-2026 are stronger, with real GDP growth hitting a six-quarter high of 8.2% as per Q2FY26. India’s FX reserves increased to a record $723.8 billion as of January 30, 2026, underlining sectoral resilience against external economic shock. Chief Economic Adviser Anantha Nageswaran has also commented on the INR depreciation, stating that it is broadly in line with trends seen across emerging market currencies. The depreciation is more associated with external factors rather than domestic imbalances: prolonged FPI outflows, geopolitical tensions regarding tariffs and previous uncertainty surrounding the India-US trade deal. Currently, a weaker INR acts as a natural global shock absorber and increases India’s export competitiveness, and, most importantly, preserved the FX reserves in a period of extreme geopolitical uncertainty. The RBI’s current approach has been described as “crawl-like”, and is more resilient and better aligned with India’s current position. The INR depreciation currently serves as an adjustment mechanism to global headwinds, rather than as a reflection of structural weakness.