Rupee faces sustained pressure: India’s current account recorded a deficit of $2 billion in May, compared with a surplus of $0.7 billion a year earlier. The balance of payments was in deficit by about $11 billion over April and May. The cause is straightforward. Imports have risen faster than exports, while foreign investment has weakened. Services exports and remittances have cushioned much of the rising merchandise trade deficit, but not the capital outflows.
The rupee closed at a two-month-low of 96.35 to the dollar on July 16. The RBI can use its reserves to prevent a disorderly fall. Defending a particular exchange rate is another matter, especially when both the current and capital accounts are under pressure.
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Depreciation will raise the rupee cost of oil, edible oils, electronics and industrial machinery. Households will also pay more for overseas education and travel. The inflationary effect will depend on how much of the higher import bill companies pass on to consumers.
Trade deficit widens despite export growth
Merchandise exports rose in May, but imports grew faster. RBI data put goods exports at $46.1 billion and imports at $74 billion, leaving a trade deficit of nearly $28 billion.
The Commerce Ministry’s customs-based data tell a similar story. They put the May merchandise deficit at $28.21 billion, with crude oil and related imports rising by nearly 54 per cent from a year earlier to $22.68 billion.
Services and remittances continue to cover much of this deficit. Net services exports stood at $15.7 billion in May, little changed from a year earlier, while net transfers, largely remittances, rose to $13.6 billion. Software, business services and money sent home by Indians abroad remain the strongest parts of the external account.
That support was insufficient once capital flows turned negative. Foreign portfolio investors withdrew $4.7 billion in May. Net foreign direct investment was negative, while external commercial borrowing slowed. The balance of payments consequently remained in deficit even with large receipts from services and remittances.
Foreign capital adds to rupee pressure
A current account deficit need not weaken the currency if foreign investment finances it. Pressure builds when the trade gap widens and capital leaves at the same time.
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The rupee need not fall sharply. The RBI can sell dollars to prevent disorderly trading, and higher interest rates or lower oil prices may bring some capital back. But the underlying numbers support further depreciation unless foreign inflows recover.
Imported inflation is the immediate concern. Companies that buy components, medical equipment, machinery or raw materials abroad must absorb the higher rupee cost or raise prices. The effect on profits and consumer prices will vary with the share of imports and the pricing power of each company.
Currency weakness also complicates the RBI’s August monetary policy decision. The central bank need not raise rates merely because the rupee has fallen. But it may have less room to cut if depreciation raises fuel and other import costs. The relevant question will be how much of the exchange-rate movement reaches retail inflation.
Foreign portfolio flows can amplify a fall in the rupee. Depreciation reduces the dollar value of returns from Indian assets, encouraging some investors to sell. Those sales create further demand for dollars. RBI intervention can slow this movement but cannot erase the trade and capital-flow imbalance.
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Rupee outlook depends on FDI and exports
Reducing imports of energy, electronics and semiconductor components would lower demand for dollars. Production-linked incentives, domestic semiconductor projects and renewable-energy investment may help over several years. They cannot materially change the external account in FY27.
India therefore needs more stable foreign capital. FDI is less sensitive than portfolio investment to short-term changes in global interest rates and risk appetite. Yet net FDI has weakened as overseas investment by Indian companies and the repatriation of earlier foreign investment have increased.
Export competitiveness and private investment will have a greater bearing on the rupee than repeated intervention in the currency market. If imports continue to outpace exports and foreign capital remains scarce, depreciation will continue. India has the reserves and services income to avoid an external payments crisis. It does not have enough capital inflows to prevent the rupee from carrying part of the adjustment.