A Paradox of Global Finance: Weak Dollar, Weaker Rupee
The financial year 2026 has presented a curious paradox for India. While the world grapples with exceptional US dollar weakness, driven by policy unpredictability and the Trump tariffs, the Indian rupee has failed to benefit. Instead, it has faced the strongest depreciation pressures among key Asian currencies. This divergence highlights unique domestic challenges overshadowing global trends.
The Core Problem: Weak Capital Flows
The primary driver of the rupee's weakness is not the current account but a significant slowdown in capital inflows. Data reveals a stark picture: in the first seven months of FY26, net Foreign Portfolio Investor (FPI) inflows have been nearly zero. This is a dramatic fall from the US$10 billion inflows witnessed during the same period last year.
This trend sets India apart from other emerging markets (EMs). While EMs collectively saw a 22% year-on-year increase in FPI inflows, totalling US$188 billion in FYTD26 (till September), India is moving in the opposite direction. Analysts suggest this divergence indicates that global investors view Indian equities as overvalued.
Debt inflows have also moderated following the normalization after India's inclusion in the JP Morgan EM bond index, which was completed in March 2025. A silver lining exists in Foreign Direct Investment (FDI), where net inflows have picked up to US$10.1 billion in FYTD26 (till August), supported by reduced repatriation pressures, compared to US$3.3 billion in FYTD25.
However, the overall capital account—encompassing FDI, FPI, external borrowings, and banking capital—is estimated to have turned negative in Q2–Q3FY26. This has intensified depreciation pressure on the rupee and forced more active intervention from the Reserve Bank of India (RBI).
Current Account: A Contained but Widening Deficit
The drag from the current account has been relatively milder, though concerns are growing. The trade deficit widened to US$155 billion in H1FY26 from US$145 billion in H1FY25. A significant contributor to this is a surge in gold imports, which rose 16% YoY to US$26.5 billion, partly reflecting higher global prices.
The impact of bilateral tariffs is becoming evident. India's exports to the US declined 12% YoY in September 2025—the very month when the 50% bilateral tariff came into effect. Some negative impact was cushioned by frontloading of exports during the pause period when only a 10% tariff was applicable.
The trade deficit is projected to widen to US$327 billion in FY26, up from US$287 billion in FY25. Despite this, the overall current account deficit remains low, supported by a strong services surplus and robust remittance inflows. It is estimated at 1.3% of GDP for FY26, up from 0.6% last year.
Risks persist for the future. The proposed outsourcing tax under the US HIRE Act and higher H1-B visa costs could negatively impact India's vital services exports and remittances over time. The US is the largest source of remittances, accounting for 28% of gross inflows.
RBI's Evolving Intervention Strategy
The most critical factor influencing the rupee's trajectory is the RBI's intervention in the foreign exchange market. This year, the central bank's strategy has shifted noticeably. Compared to the same period last year, RBI intervention was initially lower, leading to greater two-way volatility in the USD/INR pair.
To illustrate, the RBI's net dollar selling in the spot and forward markets in FY26 (till October) is estimated at US$34 billion. This is substantially lower than the US$55.8 billion sold over just four months (October 2024 to January 2025) last year.
This change was driven by a need to manage the build-up of net dollar short positions in its forward book. Last year, the RBI used buy-sell swaps, causing its forward book to swell from US$14.6 billion in September 2024 to US$88.8 billion in February 2025. This year, the focus shifted to reducing this forward book, which reached a near-term low of US$53.4 billion in August 2025.
However, since September 2025, persistent depreciation pressure has forced the RBI to become more proactive. It has increased its intervention across spot, forward, and non-deliverable forward (NDF) markets. This is reflected in the forward book rising again to US$59.4 billion in September. In October 2025 alone, the RBI engaged in US$17 billion of net dollar selling. While this has reduced volatility, the associated liquidity drains limit how long such aggressive measures can be sustained.
This analysis is based on the views of Gaura Sengupta, Chief Economist at IDFC FIRST Bank.
