Indian rupee set for worst annual fall in three years amid equity outflows

Core Viewpoint - The Indian rupee is experiencing its largest annual decline in three years, primarily due to record equity outflows and the absence of a U.S. trade deal, with recovery prospects linked to future trade agreements [1][3]. Currency Performance - The rupee is currently quoted at 89.8650 per U.S. dollar, reflecting a 4.74% decline for the year, marking its worst performance since 2022 when it fell nearly 10% [1]. - Throughout the year, the rupee has repeatedly hit record lows, surpassing the 91 level at one point, indicating sustained depreciation pressure [2]. Economic Context - India's balance of payments has slipped into a historical deficit of approximately $22 billion between April and November, highlighting external economic strains [3]. - A potential trade deal with the U.S. could provide temporary relief, possibly lifting the rupee to around 88.50 by March, although underlying pressures are expected to persist [3]. Capital Flows - The rupee's underperformance relative to peers is attributed to significant equity outflows and a slowdown in capital inflows, with foreign investors withdrawing a record $18 billion from Indian equities in 2025 [5]. - Prolonged negotiations with the U.S. have further complicated capital flow challenges, reducing predictability regarding India's trade outlook [5][6]. RBI's Approach - The Reserve Bank of India (RBI) has adopted a more flexible approach to currency management under Governor Sanjay Malhotra, allowing for currency weakness while focusing on managing depreciation expectations [7]. - This shift became evident when the rupee fell past the 91-per-dollar mark, prompting heavy RBI intervention to manage speculative pressures without defending a specific exchange rate level [8]. Currency Valuation - India's trade-weighted real effective exchange rate has declined to 97.5 in November from 104.7 in January 2025, indicating that the rupee is now considered undervalued [9]. - A weaker Indian rupee may benefit local exporters by cushioning their currency earnings, providing some relief amid challenging economic conditions [10].