The Rupee's problems runs deeper

Business Standard June 15, 2026

On June 5, the Indian authorities took out a bazooka to rescue the rupee. The RBI announced a series of measures, providing subsidies to state-owned companies taking overseas loans, introducing a new version of the dollar-deposit scheme for NRIs, last seen in 2013, and removing restrictions on foreign investment in bonds and equities. At the same time, the government exempted foreign investments in government bonds from tax on interest and capital gains. The announcements are ambitious in scope. But will they be effective? There are reasons to be sceptical.

To begin with, it is important to recognise that the rupee’s weakness has not been caused solely by the war in West Asia. In fact, the rupee was the worst performing currency in Asia last year, depreciating by more than 6 percent against the dollar. This suggests that there is more to the story. The obvious question is: why have foreign investors been taking money out of an economy that, according to the latest official data, is growing at nearly 8 percent, faster than any major economy in the world?

The answer lies in two other shocks that India has been facing. These shocks have received relatively less attention but are likely to have a longer-lasting impact. What are these shocks and how should the economy adjust?

The first of these could be termed the China shock. Until recently, the dominant narrative among investors was that India would gain significantly from the shift of global manufacturing out of China. The logic seemed compelling: a vast pool of low-cost labour, the government’s incentive schemes for the manufacturing sector and a rapidly expanding domestic market. Since 2008, India’s GDP has risen fourfold, from about $1 trillion to $4 trillion, reinforcing the perception that the country offered both a production base and a sizeable consumer market.

However, things have not turned out as expected. For a start, the shift out of China has been smaller than anticipated. China continues to be the workshop of the world, even expanding into new sectors (such as automobiles) where it previously did not have any major international presence. Moreover, the manufacturing that has shifted out of China has generally not come to India. Gross FDI to India has in fact fallen as a percent of GDP, from 3.6 percent in 2008 to less than 1 percent in 2024. The major beneficiaries of the China+1 shift have been in East Asia, with Vietnam in particular seeing its FDI ratio surge to more than 5 percent.

While foreign firms have been reluctant to invest in India, Indian firms have been expanding their investments abroad. Outward FDI has doubled over the past two years from roughly USD 15 billion to more than USD 30 billion in 2025-26, even as domestic investment has remained sluggish. In other words, India has not been able to present itself as an attractive manufacturing location, either to foreign or to domestic firms.

In addition to this, the economy is facing a second major shock: AI, which is threatening the country’s flagship IT sector. Despite India’s software prowess, it is lagging well behind the US and China in developing AI platforms and shaping global AI development. The Nifty IT index has fallen roughly by 22 percent over the past year. This in turn has forced the IT firms to retrench. Hiring has fallen sharply, while anecdotal evidence suggests that the top IT firms have laid off around 40,000-50,000 employees since 2024.

Taken together, these two shocks have exposed the vulnerabilities in India’s growth narrative. If the twin drivers of manufacturing and IT services are under strain, where will sustained, high growth come from? New pillars can certainly emerge; they have in other Asian economies. China, South Korea, and Taiwan have proved their potential to move up the value chain and establish a global presence in frontier industries such as AI hardware and electric vehicles. The Indian manufacturing sector however, has yet to make a similar transition.

The takeaway is straightforward. As expectations of India’s growth prospects have moderated, both FDI and portfolio flows have weakened, to the point where they are no longer sufficient to finance even a modest current account deficit. This implies that short-term dollar inflows triggered by the recently announced measures are unlikely to solve the problem. Instead, the economy needs to adjust.

There are two ways this could play out. One way is for investors to mark down the prices they are willing to pay for Indian assets, to reflect the economy’s weaker growth prospects. Under this scenario, share prices would correct, pulling market valuation down from its lofty 20-23 price to earnings ratio to the 12-17 range more typical of emerging economies. Alongside this, the Indian rupee would depreciate further. As Indian assets become less expensive, foreign capital will eventually be enticed to return, in sufficient quantity to finance the current account deficit, now running around $100 billion a year.

Such a scenario would not be particularly appealing because those who have invested in Indian assets would lose considerable amounts of money.

The alternative is to restore confidence in the economy’s growth prospects. This is a better option but it is also harder to achieve. It would require decisive measures to address the factors holding back investment-both domestic and foreign. It would also require something that has so far been in short supply: a willingness to recognise that the concerns being expressed by investors may not be entirely misplaced.

Why RBI’s regulatory intervention is the wrong way to defend the rupee

Why RBI’s regulatory intervention is the wrong way to defend the rupee, The Print, June 1, 2026.

Words and deeds in the Indian exchange rate

Words and deeds in the Indian exchange rate, The Leap Blog, May 19, 2026.

The rupee’s decline is part of the solution, not the problem

The rupee’s decline is part of the solution, not the problem, The Print, May 18, 2026.

The power of prices in times of crisis

Business Standard May 18, 2026

When an economy is hit by a shock—whether a war, or a pandemic—it can adjust in two broad ways: through prices or through administrative controls imposed by the State. Market economies rely primarily on prices. Centrally planned systems depend on bureaucratic allocation. The distinction matters because prices allow millions of households and firms to adjust voluntarily, whereas controls require the State to decide who gets what, and at what price. The current disruptions in global energy markets offer a useful illustration of why this difference matters.

Consider a simple example. Suppose an economy normally consumes 100 units of fuel, but a global disruption reduces available supply to 80. Since supply cannot quickly increase, demand must fall to match it. This can happen in only two ways: either the State forces demand down through rationing and controls, or prices rise and people voluntarily reduce consumption until demand matches supply.

The second mechanism is often far more efficient and less disruptive. Let’s understand why.

First, prices perform two critical functions: they convey information and shape incentives. In many ways, the market is like a giant opinion poll—except people back their views with money. Prices aggregate the decisions of millions of consumers, businesses, traders, and investors into a single signal about scarcity or abundance.

When fuel prices rise people respond by driving less, postponing discretionary travel, or shifting to public transport, while businesses cut wasteful energy use or seek alternatives. Producers receive the opposite signal: higher prices encourage them to increase supply, reroute shipments, or find substitutes.

The alternative is for the State to make these decisions. But this raises difficult questions. If cooking gas becomes scarce, should priority go to households or restaurants? Small eateries or luxury hotels? Should fertiliser subsidies go equally to all farmers or mainly to small farmers?

There are no easy answers because no State can fully understand the preferences of millions of households and businesses. Prices solve this coordination problem more effectively by allowing people to adjust their own behaviour as conditions change. This preserves economic freedom and ensures that decisions about what to consume, conserve, or prioritise are made by those directly affected, rather than by a central authority with limited information.

Secondly, State interventions often create unintended consequences. Export bans on agricultural products can depress farm prices and discourage production, while restrictions on gold imports can lead to shortages, black markets, and smuggling. Artificially suppressing prices may feel comforting initially, but the costs eventually appear elsewhere, often through higher taxpayer burden.

Since the West Asia war began, India’s state-owned oil companies have incurred losses of around Rs 1 lakh crore as fuel prices were kept largely unchanged. In effect, consumers face a trade-off: either reduce fuel consumption today in response to higher prices or pay more than Rs 1 lakh crore in taxes at a future date. Most countries have raised fuel prices since the war started including Malaysia, Pakistan, and Philippines where prices have gone up by 50%. India, in contrast, has adjusted the least, allowing fuel prices to go up by only 3%.

Finally, repeated State intervention can create uncertainty because people stop responding to market signals and start trying to anticipate State actions instead. Businesses delay investment decisions because they do not know what new controls, or bans may appear next. This weakens confidence in the broader policy environment.

Over time, mature market economies have learned to trust prices. After Russia invaded Ukraine in 2022, Europe allowed energy prices to rise, which encouraged conservation, reduced demand, and attracted LNG supplies from around the world, helping avoid a deeper shortage. The US has followed a similar approach during the current West Asia conflict. Despite being largely self-sufficient in oil, gasoline prices have risen by about 45 per cent, allowing the market to allocate scarce fuel more efficiently.

This adjustment mechanism is also transparent and reversible. As supply conditions improve, prices naturally fall back, allowing normal economic activity to resume without the State having to dismantle complex controls and restrictions.

India itself has undergone this learning process gradually over the past few decades. There was a time when people expected the State to determine prices of petrol, steel, or airline tickets. Today, most accept that these prices move with market conditions. Yet large shocks such as wars still trigger demands for intervention. Policymakers increasingly need to recognise that markets are better at determining prices than the State. Where prices remain controlled, such as petrol and diesel, a more effective approach may be to announce future price increases in advance, giving households and firms time to adjust.

Prices are not the problem. They are how economies adjust to shocks. The role of policymakers is not to suppress these signals, but to protect the vulnerable in a targeted manner while allowing the price system to continue doing its job.

Let the rupee move freely: RBI intervention risks more harm than good

Business Standard April 21, 2026

The Indian rupee has been under intense scrutiny in recent weeks, with its depreciation against the US dollar attracting widespread attention. Much of the commentary has framed this decline as a sign of weakness, often applauding the central bank’s efforts to resist it. But this view overlooks a basic point: The exchange rate is a price. And like any price, it must adjust to shifts in demand and supply. Trying to hold it at an artificial level does not fix underlying imbalances — it only postpones the adjustment and risks making the eventual correction more disruptive.

Consider a familiar example. When the monsoon fails, the supply of vegetables falls short of demand. Prices rise, and this serves a purpose: Households cut back consumption, and farmers are encouraged to bring as much produce as possible to the market. The imbalance begins to correct itself.

Now imagine the government steps in to prevent prices from rising. The gap between demand and supply does not disappear—it simply persists. To manage it, the government would then have to impose restrictions, such as rationing or limits on sales. In the end, consumers would face shortages and reduced access, defeating the very purpose of the intervention. This is precisely why governments typically allow such prices to adjust rather than trying to control them.

The same logic applies to the foreign exchange market. When demand for dollars exceeds supply, the price of the dollar rises—and the rupee falls. What we are seeing today is simply this basic market adjustment at work.

So why is demand for dollars rising faster than supply? There are two main reasons.

First, India has been running a current account deficit, which was around $40 billion in 2025-26, but foreign capital inflows were insufficient to finance it. This imbalance helps explain why the rupee was already under pressure last year.

Second, the war in West Asia has made matters worse. By pushing up the prices of key imports, it is likely to widen the current account deficit further—potentially to around $80 billion this year.

As a result, India faces a difficult challenge: It needs to attract around $80 billion in foreign capital at a time when global investors are becoming more risk-averse and pulling money out of emerging markets into safer developed economies. In such a situation, the most practical way to restore balance is to allow the rupee to depreciate.

How does depreciation help? In much the same way that higher vegetable prices restore balance—by reducing demand and encouraging supply. The exchange rate works through two key channels.

First, a weaker rupee helps restore balance through trade. As it depreciates, Indian goods become cheaper for foreign buyers, boosting exports and bringing in more dollars. At the same time, imports become more expensive, which reduces domestic demand for foreign goods. Together, these effects help narrow the current account deficit.

Second, a weaker rupee makes Indian financial assets cheaper for foreign investors. In dollar terms, Indian stocks and bonds now cost less, which can make them more attractive. This can encourage foreign investment into Indian markets, bringing in dollars and helping to finance the current account deficit.

In contrast, if policymakers try to hold the exchange rate at an artificial level, the underlying imbalance does not disappear—it lingers, and can even intensify over time.

The main reason is that the market is aware of the $80 billion funding gap—and that the central bank cannot finance it indefinitely by selling dollars, since it will eventually run out of reserves. Unless this gap is expected to close on its own, some depreciation of the rupee becomes inevitable. Faced with this prospect, firms and households will naturally look for ways to safeguard their wealth, including shifting part of it abroad.

There is another concern. When the central bank tries to manage the exchange rate, the private sector shifts its focus from market signals to guessing the central bank’s next move. This uncertainty can itself be destabilising. If the currency is supported through restrictions—such as the recent curbs on gold and silver imports—it can unsettle the private sector and raise fears of further controls. Such fears can trigger precautionary behaviour, with firms and households pre-emptively moving money out of the country, adding to the pressure on the rupee.

In other words, attempts by the central bank to hold back the rupee risk doing more harm than good — by eroding confidence, fuelling uncertainty, and distorting market signals. This can widen the gap between dollar demand and supply, discourage investment, and complicate economic recovery. The exchange rate is not the problem; it is the mechanism through which the problem is corrected. Holding it back only delays the adjustment and makes the eventual cost higher.

In these circumstances, the most effective policy is also the simplest: Allow the rupee to move freely and do its job as the economy’s primary shock absorber.

From scale to depth: Dismantling frictions within India’s financial inclusion juggernaut

From scale to depth: Dismantling frictions within India’s financial inclusion juggernaut, Ideas for India, April 20, 2026.