The India-U.S. trade deal offers breathing room for a currency that’s been on the ropes. But can improved sentiment overcome the structural headwinds that have plagued the rupee for over a year?
The Indian rupee rebounded to around 90.5 per dollar on Monday, pulling back from 92 touched just last week. The catalyst of course, Donald Trump’s announcement slashing tariffs on Indian goods from 50% to 18%, accompanied by the removal of an additional 25% punitive duty that had been imposed over India’s Russian oil purchases.
For a currency that has spent 15 months in retreat losing 3.64% over the past year, and hitting its worst monthly performance since September 2022, the timing couldn’t be better.
“The trade deal will work to enhance capital flows to India, thus improving India’s balance of payments,” Nuvama’s analysis noted. “Expect INR to appreciate, which has been underperforming EM FX for more than a year now.”
The rupee needed this lifeline. Foreign portfolio investors have yanked more than $34 billion from Indian equities since October 2024—the steepest outflow among all emerging markets. The hemorrhaging has been relentless: state-run banks have been forced to intervene repeatedly, offering dollars to prop up the currency amid what traders describe as “ongoing market stress.”
The REER Story: Undervalued and Oversold
Perhaps the most compelling case for rupee appreciation lies in valuation metrics that both brokerages highlighted extensively. The rupee’s real effective exchange rate—the inflation-adjusted, trade-weighted measure of currency strength—is trading near its lowest levels since fiscal 2015.
“REER is already near the lowest levels since FY15,” the Nuvama report emphasized, pointing to a currency that has become fundamentally undervalued against its trading partners. This matters because REER readings below historical averages suggest the currency has room to strengthen without damaging export competitiveness.
Antique’s analysis echoed this view, noting that “FPI equity inflow and stronger domestic macro may lead to INR appreciation in the near term (REER is already near the lowest levels since FY15).”
The Balance of Payments Boost
The mechanics of how the trade deal supports the rupee are straightforward but powerful. India was facing potential export losses of roughly $50 billion—about 1.2% of GDP—under the original 50% tariff regime. Labor-intensive sectors like textiles ($25 billion in exports), gems and jewelry ($10 billion), machinery ($13 billion), and chemicals ($5 billion) were staring down the barrel of becoming uncompetitive in America’s vast market.
“Labour-intensive sectors such as textiles, gems/jewellery clearly stand to benefit,” the Nuvama report stated. “It is these segments which bore the maximum brunt of Trump 50% tariffs.” By slashing tariffs to 18%, the deal rescues these export flows and prevents a dramatic widening of India’s current account deficit.
The deal should reverse capital flows. With U.S. investors accounting for 41% of foreign institutional holdings in India, and Indian equity valuations now back near historical averages versus other markets, the money has clear reasons to return. “This will also help improve domestic liquidity conditions,” Nuvama added, pointing to the transmission effects beyond just the exchange rate.
Can Sentiment Overcome Structure?
The central question is whether improved sentiment can overcome the structural forces that have weighed on the rupee for over a year. The bulls point to $34 billion in potential foreign inflows reversing, GDP growth getting a 50-80 basis point boost, and a currency trading well below fair value on REER measures.
The bears counter with oil price risks, structurally higher import commitments, record government borrowing of 17.2 trillion rupees that spooked markets during the recent budget, and a global environment where Trump’s trade wars could still trigger “a deflationary impulse to the global economy, hurting trade, growth and earnings everywhere, including India,” as Nuvama warned.
The Reserve Bank of India, which has been intervening sporadically to manage the rupee’s decline rather than aggressively defending any particular level, will likely continue its light-touch approach. Analysts are watching the central bank’s February 6 monetary policy meeting for signals.
For now, the rupee has caught a break it desperately needed. Whether this proves to be the inflection point that ends 15 months of underperformance, or just a temporary reprieve before structural headwinds reassert themselves, will depend on whether those $34 billion in foreign outflows actually reverse—and how quickly.
