Rupee Depreciation: Persistent Threat from Weak Capital Flows and Global Fiscal Stress

Indian Economy Faces Pressure as Capital Flows Weaken

The Indian economy has been facing significant stress in the form of a depreciating rupee, despite the recent removal of tariffs imposed by the US government. The Supreme Court's decision to strike down the tariffs had raised hopes that the Indian currency would improve, but this has not been the case.

Capital Account Concerns

The stress on the Indian economy is not due to the current account, but rather the capital account. Capital flows have significantly weakened, with net outflows of US$ 10 billion in Q3FY26 and continued outflows in Q4FY26 and Q1FY27. This trend is not a post-war phenomenon, as balance of payment (BoP) data reveals that capital account outflows were present even before the war.

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Global and Local Factors

The global economy is suffering from a fiscal crisis, with elevated sovereign debt levels in the US and Europe. The US government's operational expenses are running at an estimated US$ 25 billion, with early estimates suggesting the initial weeks burned roughly US$ 890 million per day. The Trump administration is also forced to return the tariffs collected before the Supreme Court struck down the tariffs as illegal. This has led to higher US Treasury yields, which in turn has slowed down flows to EM economies, including India.

Government Measures

The Indian government has focused on driving austerity measures to save foreign exchange resources. The Reserve Bank of India (RBI) has also taken measures to weed out speculative demand from the currency market and cap the Net Open Positions of the banking sector to US$ 100 million. Recent measures have targeted reducing the imports of gold, which stood at US$ 72 billion in FY26.

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Gold Import Restrictions

To ease the pressure on the INR, the government has hiked import duty on gold and silver imports to 10 percent from 5 percent, and Agricultural and Infrastructure Development Cess (AIDC) to 5 percent from 1 percent earlier, taking the total effective import duty to 15 percent with effect from May 13. The import quantity restriction of 100 kg has been imposed on manufacturers, including in SEZ under Advance Authorization scheme.

Impact on CAD and Capital Flows

Our gold team estimates that the volume of gold imports can crash to around 420 tonnes in FY27, from 720 tonnes in FY26. This is expected to result in a savings of around US$ 23 billion. However, the challenges on the capital account side are expected to continue, with the BoP deficit anticipated lower at USD 48 bn with the given assumption on oil. The gold import restrictions are expected to ease the pressure on INR, but not completely take it away, unless the BoP gap is bridged.

Forecast

Our calculations now indicate a CAD/GDP of 1.7 percent, from our earlier estimate of 2 percent, with assumption of oil at US$ 95 per barrel. We anticipate USD/INR at 97.00-97.50 by close of H1FY27.

Note: The table shows the net outflows from the capital account in Q3FY26, and the total BoP deficit anticipated for FY27.