What really makes a currency strong? 

The rupee’s exchange rate against the US dollar basically changes depending on the relative demand for the two currencies in the foreign exchange (forex) markets. When India needs more dollars to buy oil, gold, fertilisers, electronics and other imports, the demand for dollars rises. When foreign investors pull money out, the supply of dollars weakens. The rupee then comes under pressure. 

The current pressure on the rupee reflects rising oil prices, capital outflows, rising gold imports, and a widening trade deficit. The rupee is not only falling, it is also signalling stress. If the rupee is not allowed to adjust, the pressure does not disappear. It moves into reserves, inflation, interest rates, or import compression. 

This is why currency strength needs to be redefined. It is not about a high nominal value. It is about stability, credibility, and shock absorption. The real question, therefore, is whether the economy can absorb the shock. And how a country manages its exchange rate becomes central to that process.

India’s exchange rate system

India’s exchange rate system lies between two extremes. A pure float allows the currency to move freely with market forces. A fixed or pegged exchange rate, by contrast, commits the central bank to maintaining a specific value against another currency or a basket of currencies. 

India follows neither model in a strict sense. Since March 1993, India has had a market-determined exchange rate system, with RBI intervention when needed. In practice, this is a managed float. The rupee is allowed to move, but not to fall in panic. 

This difference matters. If markets believe that the RBI will defend a specific exchange rate level – 96 or 97 against the US dollar – at any cost, they may start testing the central bank. Importers may rush to buy dollars, exporters may delay converting their dollar earnings, and traders may build one-sided positions. This can deepen the very pressure the RBI is trying to contain. 

Recent numbers show the burden of such management. India’s foreign exchange reserves had earlier touched a record high of USD 728.49 billion in the week ended February 27, but stood at USD 696.99 billion as of May 8, 2026, with foreign currency assets (a major component of the reserves) at about USD 552.39 billion.

These are not crisis numbers. India still has a sizable reserve buffer. But they do indicate that the pressure is real. The rupee’s movement cannot be understood by looking at the spot exchange rate or the current market price of the rupee against the US dollar. One must also watch reserves, the RBI’s forward book, oil prices, foreign portfolio flows, and current account. These indicators help understand the source of pressure.

The many pressures weighing on rupee 

The present fall of the rupee has not come from a single source. Several pressures have arrived together. 

Oil 

The first is oil. India imports nearly 90 per cent of its crude oil needs. Total crude oil import value stood at USD 144.009 billion in 2025-26, according to the Petroleum Planning & Analysis Cell, the Ministry of Petroleum and Natural Gas. 

When crude prices rise, the import bill widens, inflation risks increase, and pressure on the current account grows. For instance, the volume of crude purchased by India in April this year fell by 4.3 per cent compared with the same period last year, but the import bill surged by more than 50 per cent due to a sharp rise in global oil prices, provisional data by the Petroleum Planning and Analysis Cell showed.

Total import value rose from USD 14.45 billion in March 2026 to USD 17.90 billion in April 2026. Net import value rose from USD 8.911 billion to USD 13.469 billion.

Capital outflow 

The second pressure is capital outflow. Foreign investors have withdrawn money from Indian equities amid global uncertainty. Outward investment in April 2026 was USD 5.64 billion, up from USD 5.08 billion in March 2026. Foreign institutional investment flows also weakened sharply in March 2026, showing a strong net outflow. It appears to be one of the largest recent negative foreign institutional investment movements. 

Dollar system

The third is the dollar system itself. The dollar remains the centre of global finance. Oil is priced in dollars. In uncertain times, investors return to dollar assets. When the US Federal Reserve keeps interest rates high, or when global investors become risk-averse, emerging markets cannot lead the cycle. They follow it. 

This is the hard truth of the global economy. India is large, but it does not control the dollar cycle. It can manage the impact, but it cannot command the tide.

India is not facing a severe currency crisis, but there are warning signs that cannot be ignored. The latest trade data show why. In FY 2025-26, India’s total exports of goods and services were estimated at USD 860.09 billion, rising by 4.2 per cent over the previous year. But imports rose faster to USD 979.4 billion, growing by 6.5 per cent. As a result, the overall trade deficit widened from USD 94.7 billion in FY 2024-25 to USD 119.3 billion in FY 2025-26.  

Gold imports 

Gold imports add another layer of concern. India’s gold import bill for 2025-26 stood at USD 71.98 billion. Imports of machinery help expand future production. But when gold imports rise, dollars leave the country without creating a direct export-generating asset. 

This makes gold particularly important in any discussion of rupee depreciation. Oil imports are essential, but gold imports are avoidable. When the rupee weakens and households or investors buy more gold to protect their wealth, they may unintentionally add to the same pressure they fear. More gold imports mean more demand for dollars, and higher demand for dollars puts further pressure on the rupee. These pressures shape policy choices. 

The Mundell-Fleming trilemma

The RBI is navigating what economists call the “impossible trinity” or the Mundell-Fleming trilemma. No central bank can simultaneously maintain a fixed exchange rate, allow free capital movement, and retain independent monetary policy. 

An adequate response may be disciplined management of adjustment – not the defence of a comfortable exchange rate. If the RBI spends reserves aggressively to hold the rupee at 90 or 95 against a US dollar, it risks weakening the very buffer during external shocks. If it raises interest rates primarily to attract foreign capital inflow, it risks suppressing the domestic investment and credit growth that the economy cannot afford to lose.

While the better approach may be a calibrated intervention, the deeper answer is structural. India needs to reduce oil dependence, expand domestic energy buffers, encourage gold recycling, deepen financial savings, raise merchandise export capacity, reduce avoidable imports, and attract stable long-term capital. The rupee cannot be stabilised by the RBI alone. It needs to be supported by a stronger production base. 

The rupee’s decline is therefore neither a failure nor something entirely harmless. It is a warning, an adjustment, and a test. A currency that bends under pressure may be doing exactly what it needs to do. The challenge is not to prevent every decline, but to ensure the fall does not become a fracture, and to build the economic foundations that reduce how often such pressure. 

Post read questions

Examine the major factors responsible for the recent pressure on the Indian rupee. How do oil imports, capital outflows, and gold imports affect exchange-rate stability?

The strength of a currency lies not in its nominal value but in its ability to absorb shocks. Critically examine.

Discuss the nature of India’s exchange-rate regime. How does a managed float differ from a fixed and a freely floating exchange-rate system?

Evaluate the role of foreign exchange reserves in managing currency volatility. Are reserves sufficient to ensure exchange-rate stability?

How do global financial conditions, especially the US dollar cycle and Federal Reserve policies, influence emerging-market currencies such as the Indian rupee?

(Pushpendra Singh is an Assistant Professor of Economics at Somaiya Vidyavihar University, Mumbai, and Archana Singh is an Assistant Professor of Gender and Economics at the International Institute for Population Sciences, Mumbai.)  

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