How Far Could the Rupee Slide?

The whole market and Indian economy, and its analyst community, are busy focusing on uplifting the statements that will get Nifty back to the 26000 levels. For this, we want to ignore every negative aspect and risk of the market. We have diverted our mind to the Iran war and its impact on the Indian market, whereas at home, we have a major issue of depreciating uncontrolled INR. INR have been a major issue in the last  6 years since the day we got into Covid lockdown. The FII’s are also sceptical to invest in India for this particular reason, more than the valuations and earnings. The current fall is an opportunity that DIIs and FII’s both know, but does that excite FIIs to invest or redeem?

India's forex reserves at ~$710 billion look ample (covering ~11 months of imports), but quality matters more than quantity:

Foreign Currency Assets (FCA) erosion: Down to $555 billion from $621 billion in September 2024—a 10%+ drop. FCA's share has shrunk to <78% from >90% pre-2020, limiting RBI's dollar-selling firepower for interventions.

Gold dominance: Holdings up ~4x in five years (now ~$70–80 billion equivalent at current prices), boosting total reserves but illiquid for daily FX defence. RBI sold minimal gold historically; it prefers spot USD.

Likely $80–100 billion now (official data lags), tying up future dollars for importers/exporters. This amplifies intervention costs without immediate liquidity. RBI data (weekly bulletins up to March 2026) confirms these trends. Similar 2021–22 dips saw INR hit 80/USD before a partial recovery.

External and Domestic Triggers:

Current account flip: Q4 surpluses (0.2–0.7% GDP) relied on services exports ($110B+ annually) and remittances ($30B+ quarterly). Now, trade deficit widened to $30B/month (oil at $75–80/barrel, imports up 15% YoY), Middle East tensions cut remittances 5–10%, risking 1–2% GDP deficit.

Capital outflows: FIIs pulled $10B+ in 2025 amid US rate hikes (Fed funds at 4.5%) and global risk-off. India's 7%+ fiscal deficit deters inflows.

REER signal: Below 100 since mid-2025 (RBI index), indicating overvaluation correction—INR "should" weaken 5–10% for competitiveness, per BIS models.

Historical parallels: 2013 taper tantrum (INR 68/USD), 2022 Ukraine shock (83/USD)—each saw 10–15% slides over 6–12 months.

India’s foreign exchange reserves have dipped below $710 billion, falling from a recent high of over $728 billion just weeks ago. On the surface, this still appears to be a comfortable buffer. However, a deeper look at the structure of these reserves points to growing vulnerabilities.

A key area of concern is Foreign Currency Assets (FCA), which have declined to roughly $555 billion. This level is not only lower than recent months but also below what India held back in 2021. Over time, the share of FCA in total reserves has steadily fallen to under 78%, compared to more than 90% a few years ago. While rising gold prices explain part of this shift, the drop in absolute FCA levels—around 10% lower than in September 2024—highlights a more structural issue.

Gold, on the other hand, has become a much larger component of reserves. Driven by both higher prices and increased accumulation, India’s gold holdings have expanded nearly fourfold over the past five years. While this adds strength to the balance sheet, it reduces the Reserve Bank of India’s (RBI) ability to actively manage the currency, since interventions typically rely on selling dollars rather than gold.

Adding to the pressure is the RBI’s forward book, which has already exceeded $60 billion and may now be approaching $100 billion. This reflects ongoing efforts to manage currency volatility but also signals rising commitments in the market.

Externally, India’s position may also weaken. The country recorded a current account surplus in the fourth quarter over the past two years, supported by strong services exports and steady remittances. This time, however, the outlook is less optimistic. A widening trade deficit and softer remittance inflows—particularly due to tensions in the Middle East, which contributes about 40% of such flows—could push the current account back into deficit.

While further RBI intervention is likely, its effectiveness has limits. It can help contain sharp volatility and speculative movements, but it cannot fully counter persistent global pressures. Continued foreign investor outflows and an unfavourable global environment could keep the rupee under strain. This is the place where FII's are concerned about, and this does not attract them to invest in India. The biggest question is that despite the current sharp correction in very pockets, will FII's invest in India now?  Unless the rupee gets into a stable form, the currency risk does not attract them. This also raises the risk of investments for DII's since they alone cannot keep the market alive for long. The SIP book might look attractive today, but it's not sustainable since, currently, every portfolio has wiped out the last 2 years' gains.

Coming to the rupee, if these trends continue, the rupee could drift toward the 97–98 range against the US dollar. The real effective exchange rate (REER), a measure of currency competitiveness, had already fallen below 100 by mid-2025 after a prolonged period of overvaluation. Past episodes—such as the oil price surges in 2007–08 and 2011–14—also saw extended periods of rupee weakness.

In summary, while India’s reserves still offer a degree of protection, their shifting composition and external risks suggest that maintaining currency stability may become increasingly difficult in the near term.