There are moments when a currency tells a story more honestly than official statements do. The Indian rupee is doing exactly that. It has lost more than 12 percent against the US dollar in 12 months and has been sliding relentlessly even though India’s macroeconomic fundamentals are not in obvious crisis territory. Growth is still respectable. Inflation is not runaway. The current account deficit, at least in headline terms, is manageable. Forex reserves remain robust. This is not 1991.
But that is precisely why the rupee’s fall is worrying. If a currency weakens sharply despite decent growth and contained inflation, it is telling us that the problem lies elsewhere: in the balance of payments, capital flows, investor confidence, oil vulnerability and the structure of India’s external dependence.
India’s chief economic advisor has argued that the rupee’s depreciation is not justified by fundamentals. He points to strong growth, moderate inflation, low external debt and a manageable current account deficit. He also argues that global capital has been sucked into the artificial intelligence investment boom and dollar assets, leaving otherwise sound emerging markets under pressure.
That is a fair point. Exchange rates often reflect capital flows more than textbook fundamentals. But saying that the rupee is mispriced is not enough. A mispriced currency can still bankrupt balance sheets, raise import costs, hurt confidence and trigger defensive behaviour. Markets may be irrational for a long time, but countries must still pay their import bills in real dollars.
The real danger is that India’s external account is no longer getting the capital cushion it once did. For decades, India has run a current account deficit, but financed it through capital inflows. That bargain is fraying. Net foreign direct investment has been falling for several years. Gross inflows may still look impressive, but repatriation and outbound FDI have reduced net FDI close to negligible levels. Besides, foreign portfolio investors have pulled out close to $40 billion in the past two years. The outflow this year has been the worst in almost 15 years.
This is the heart of the matter. India’s current account deficit may be below 2 percent of GDP, but the capital account is weak. The balance of payments will be sharply negative this year. When the BoP turns negative, either the rupee weakens or the RBI sells dollars to defend it. Both are now happening.
The oil shock makes this worse. The CEA has called the West Asia crisis a live “balance of payments stress test”, with direct consequences for inflation, the current account and the exchange rate. Almost half of India’s crude imports transit through or near the Strait of Hormuz. That means an oil shock is not merely a petrol pump problem. It is a macroeconomic problem.
When oil prices spike, three things happen at once. First, the import bill rises and the current account worsens. Second, inflation creeps up because fuel enters transport, fertilisers, plastics, food distribution and almost every other supply chain. Third, the fiscal deficit worsens if the government tries to shield consumers through LPG, fertiliser or petroleum subsidies.
If pump prices are not raised, oil marketing companies take the hit. If they are raised, consumers suffer. If subsidies absorb the shock, taxpayers suffer. In reality, the three groups overlap: the taxpayer, the consumer and the shareholder are often the same Indian household wearing different hats.
There is no choice but to raise pump prices. Many prominent voices are sounding this chorus. Else the fiscal deficit worsens adding to macro stress.
Gold is the second pressure point. The Prime Minister’s appeal to citizens to avoid gold purchases is revealing. It is being described as economic patriotism. But it should also be read as a distress signal. Gold is not merely jewellery in India. It is an emotional asset, a cultural asset, a liquid collateral and, increasingly, a hedge against currency weakness. When citizens rush to gold they are also voting against fiat currency with their savings.
Raising gold import duty to 15 percent may reduce legal imports, but it can also revive smuggling. India has seen this movie before. High duties create arbitrage. Restrictions can create panic buying. If people think the government is trying too hard to stop them from buying gold, they may conclude that the rupee is in deeper trouble than officially admitted.
Remittances have been India’s great external stabiliser—larger than any single export category. But they should not be taken for granted. NRI deposits have helped, but in the past they have fled at the first sign of trouble.
So, what should be done?
First, stop pretending this is only market mispricing. The rupee may be undervalued relative to fundamentals, but the BoP stress is real. A crisis is not born on the day reserves run out. It begins when confidence weakens, capital inflows dry up, importers rush to cover dollars, residents buy gold and the central bank is forced to lean repeatedly against the wind.
Second, India must allow gradual pass-through of oil prices, while protecting the poor directly with targeted transfers. Subsidise people, not products. LPG support for poor households, cash transfers for vulnerable groups and targeted public transport support are better than suppressing pump prices.
Third, conserve dollars without crushing growth. Austerity that merely tells people to consume less will fail if it does not address equity. Asking citizens to cut gold, fuel and travel while elite consumption remains untouched will not command legitimacy. Any forex conservation drive must begin with visible restraint by government, public sector entities and luxury import consumers.
Fourth, treat gold demand as a financial market failure, not merely a cultural habit. India needs more trusted, inflation-protected savings instruments, easier access to sovereign gold bonds, or gold-linked financial products without physical import pressure, and deeper household financialisation. People buy gold because they trust it. The rupee must earn that trust.
Fifth, rebuild capital inflow credibility. Stable tax policy, faster dispute resolution, predictable regulation and genuine ease of doing business matter more than roadshows. Floating a dollar bond for NRIs with some protection against depreciation, as was tried successfully in 2013, can be explored. Also remove impediments for foreign investment in corporate bonds.
Sixth, export policy must emphasise and support product and market diversification. Services exports remain India’s strength, but merchandise exports need scale, logistics efficiency, cheaper power, faster customs and fewer policy shocks. Domestic production must become globally competitive.
Finally, build resilience before the next shock. Brazil and South Korea also face global turbulence, but their currencies have not been punished the same way. India’s vulnerability comes from chronic dependence on imported oil, imported gold, imported electronics, imported fertilisers and volatile capital inflows. A country aspiring to be a major power cannot remain permanently exposed to every oil spike, every dollar surge and every bout of foreign investor nervousness. Our energy policy has to leverage the full potential of solar. Coal-based gasification has to grow exponentially.
The rupee is not collapsing. But it is warning us. The correct response is neither panic nor denial. It is disciplined urgency. India still has time to avoid a full-blown currency crisis. But the window for complacency has closed.
Ajit Ranade | Economist based in Pune
(Views are personal)