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Summary
India's currency has been falling since before the Gulf war began, but its impact on India’s balance of payments has added to the downward pressure. The end of today’s energy crisis would bring relief, but till then, we must do what it takes to attract capital.
The Indian currency has been experiencing sharp depreciation amid the West Asian crisis, driven largely by rising energy prices and moderating capital flows. That said, the weakness of the Indian rupee has been a persistent concern over the past year, even before the conflict began. It has depreciated by about 11% over the past year, with about 5% of this value loss having occurred after the US-Iran war began on 28 February.
The main concern for the rupee is India’s weak balance-of-payments position. High global crude oil prices are likely to push up India’s import bill, while exports to West Asia and remittances from the region will also face the brunt of the crisis. We expect India’s current account deficit (CAD) to widen to 2.1% of gross domestic product (GDP) in 2026-27 from our pre-war projection of around 1%.
Moreover, global uncertainties have cast a shadow on capital flows into India. The country has also lagged in attracting a meaningful share of global artificial intelligence (AI) investments.
Foreign portfolio investments (FPI) worsened following the West Asia conflict, with outflows of $21 billion in March-April. There were net FPI outflows of $16.6 billion in 2025-26. The net FDI flows also remain muted due to higher repatriations and FDI outflows.
During April-February, or the first 11 months of 2025-26, India’s net FDI inflows were modest at $6.3 billion, following a poor $1 billion in 2024-25. This compares poorly with the annual average of $31 billion from 2014-15 to 2023-24 in net FDI inflows.
India’s foreign exchange reserves have declined by about $33 billion (as of 1 May) since the onset of the conflict, though the country still has reserves of around $690 billion. Of these, gold holdings account for $115 billion, but that is liquid and can be deployed quickly as a cushion against external shocks. Another $100 billion of India’s foreign exchange reserves are accounted for by the Reserve Bank of India’s (RBI) short forward positions, implying that usable reserves are that much lower.
However, the comforting aspect here is that in recent months, RBI has increasingly relied on longer-tenor contracts for intervention in the forwards forex market. The share of contracts with maturities exceeding one year rose to 50% of RBI’s forward book as of end-March, compared with nil in January 2025. This implies that in the near-term, there will be less liquidity stress.
India is relatively better placed on many macroeconomic parameters compared to previous stress periods for the rupee. For instance, during the ‘taper tantrum’ and ‘fragile five’ period for India’s economy (2011-12 to 2013-14), the rupee depreciated by an annual average of 11%.
During this period, average consumer inflation exceeded 8%, the Centre’s fiscal deficit averaged 5.1% of GDP and the current account deficit (CAD) averaged 3.6% of GDP. In the current crisis, in our base case scenario, we expect GDP growth to moderate to 6.7%, consumer inflation to average 4.6-5% and the CAD at 2.1% in 2026-27.
Moreover, the Centre has been on a fiscal consolidation path, with the fiscal deficit having reduced to 4.4% of GDP in 2025-26. The West Asia crisis will exert fiscal pressure through lower revenue collection and a higher subsidy burden. We estimate its fiscal cost of the crisis at 0.5% of GDP.
The other big concern is that foreign investments have been weaker than during previous crises. During previous stress periods, while there were FPI outflows, FDI inflows were relatively stable.
Unfortunately, in the current scenario, net FDI inflows are also feeble. For instance, in the 2011-12 to 2013-14 period, foreign investment (FDI plus FPI) as a proportion of GDP averaged around 2%, while in 2026-27, it is likely to be much lower at about 0.5%.
Forex reserves are comfortable with 11 months of import cover. If we adjust for forward positions, though, the import cover falls to 10 months. That, however, is still more than the 7 months during the taper tantrum and 6.5 months during the East Asia crisis.
The rupee has already weakened sharply. Hence, in the event of a resolution of the crisis, we could see some support for the currency. We expect the rupee to trade in the 92-93 range to the dollar in 2026-27, assuming an early resolution of the crisis and an average crude oil price of $90 per barrel. In case the conflict lingers on or there is further escalation, we could see a further weakening of the rupee to 96-98 levels.
The government has sharply increased the duty on gold imports to narrow the CAD. We could see further measures taken by the central bank and government if pressure on the rupee continues.
RBI could consider a range of steps including the reopening of a currency swap window for oil marketing companies and offering incentives for foreign currency non-resident bank deposits. Further liberalizing capital inflows and reducing the capital gains tax for foreign investors will help boost foreign investment flows into the country.
The likelihood of interest rate increases to stabilize the rupee is low in the near-term, given rising concerns around a slowdown in the economy’s growth on account of the crisis.
These are the authors’ personal views.
The authors are, respectively, chief economist, and senior economist, CareEdge Ratings.
English (US) ·