India’s weak currency reflects deeper problems than the Iran war
It highlights a persistent inability to draw in foreign investors
THE LATEST update to the IMF’s global economic statistics in April made grim reading for patriotic Indians. The fund estimated that Britain, home to 70m people, had overtaken its 1.45bn-strong former colony to regain the title of the world’s fifth-largest economy. India dropped to sixth place. The reordering is largely the fault of the rupee. India’s currency lost around a tenth of its value against the dollar in the fiscal year to the end of March.
The GDP rankings do not matter (beyond wounded pride). India, which is growing five times as fast as Britain, will reclaim its fifth spot before long. But the weak rupee does reflect something troubling: India’s struggle to attract the foreign capital it needs to fuel growth and finance its ever pricier imports, including of energy from the war-torn Gulf.
The head of the Reserve Bank of India (RBI), Sanjay Malhotra, previously suggested that a modest depreciation against the dollar is “normal” for a currency like the rupee—an arithmetic consequence of India’s inflation being higher than America’s. It keeps the real value of Indian and American goods equal. In the 12 months to March, however, inflation in both countries was virtually identical, at a smidge above 3%. The rupee’s 11% drop against the greenback thus resulted in a collapsing real effective exchange rate (see chart 1). Nearly two-thirds of that decline predates the Gulf energy crisis.
Foreigners have been shunning Indian assets both in portfolios and on the ground. Some $31bn have flowed out of Indian debt and equities since the start of 2025, compared with total inflows of nearly $50bn in the preceding two years. Millions of zealous domestic retail traders have pushed up valuations of Indian companies’ shares. Before the Iran-induced slump, Mumbai’s Nifty 50 index of large firms traded at some 26 times earnings, compared with a ratio of 17 in the benchmark basket of emerging-market stocks tracked by MSCI, a compiler of such things. India lacks the artificial-intelligence firms that excite investors; AI could also put some of its giant listed IT consultants such as TCS and Infosys out of business. Indian exporters face punitive American tariffs.
Net foreign direct investment has followed a similar pattern. After years in the black there were net outflows in late 2024 and early 2025, then again in the first three month of this year (see chart 2). Foreign multinationals, venture capitalists and buy-out barons have been taking advantage of high valuations to cash out. Despite recent pro-business reforms by Narendra Modi’s government, India’s shabby infrastructure and a bureaucracy that puts Byzantium to shame puts off new arrivals.
The war in Iran, now in its third month, is certainly not helping. As a big energy importer, India spends around 3% of GDP on oil, natural gas and petroleum products. Neelkanth Mishra of Axis Bank estimates that if oil stays at $100 barrel for a year, India’s current-account deficit would increase by around $80bn (2.1% of GDP). As a big emerging market, the country has also suffered from investors’ flight to the dollar, which rallied against a basket of poor-world currencies in March.
This has pushed the placid Mr Malhotra to step in. During the war the RBI’s foreign-exchange reserves have dwindled by $25bn, to around $700bn (though this also reflects a drop in the price of gold, which makes up around a fifth of the kitty). The RBI also clamped down on speculation, limiting banks’ daily bets against the rupee for the first time in 15 years, to $100m.
On April 20th the RBI reversed course on the currency bets, perhaps concluding that making it harder to hedge currency risk is not the best way to keep investors in India. Ironically, a combination of a historically cheap rupee (see chart 3) and a softer stockmarket may do a better job of encouraging them to stay put. Selling shares now would crystallise losses in dollar terms. Refraining from such sales could, Mr Mishra notes, reduce the flow of capital out of India, helping finance a larger current-account deficit. For oil, high prices are often the cure for high prices. For rupees, with luck, low prices will be. ■