Indian rupee enters 2026 on the back foot after worst annual drop in three years

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 trade deal with the U.S., which has hindered its recovery compared to other Asian currencies [1][13]. Group 1: Currency Performance - The rupee was quoted at 89.8650 per U.S. dollar, reflecting a 4.74% decline for the year, marking its worst performance since 2022 when it dropped nearly 10% [1][13]. - The currency has faced sustained depreciation pressure, falling to record lows and slipping past the 91 level at one point [1][13]. Group 2: Economic Factors - The performance of the rupee this year is largely attributed to capital flows, with the Reserve Bank of India (RBI) adopting a more flexible approach to the exchange rate [2][13]. - India's balance of payments has slipped into a historical deficit of approximately $22 billion between April and November, indicating significant external economic strains [2][13]. Group 3: Trade and Investment Outlook - 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 return [5][13]. - Foreign investors withdrew a record $18 billion from Indian equities in 2025, contributing to the rupee's underperformance relative to its peers [8][13]. Group 4: RBI's Approach - Under the new leadership of Sanjay Malhotra, the RBI has become more tolerant of currency weakness, focusing on managing depreciation expectations rather than defending a specific exchange rate level [9][13]. - The RBI's interventions have aimed to counter speculative pressures, particularly evident when the rupee fell past the 91-per-dollar mark for the first time [9][13]. Group 5: Currency Valuation - The rupee's decline, alongside a rally in other currencies, suggests it is no longer overvalued, with India's trade-weighted real effective exchange rate dropping to 97.5 in November from 104.7 in January 2025 [10][13]. - A reading below 100 indicates that the rupee is undervalued, which may benefit exporters by cushioning their local currency earnings [11][13].