Rupee Policy Must Shift Focus from Trade to Capital Flows

The Indian Rupee has been the worst-performing currency when compared to developed markets and emerging market peers since late 2024.

In 2025, the US dollar saw a large depreciation against global currencies, but in what surprised many investors, the Indian rupee weakened by close to 6% against the US dollar. This meant that the Indian Rupee fell by more than 10% against the Euro, British Pound, Swiss Franc, and even the Chinese Yuan.

With crude oil prices now approaching India’s pain threshold of $100/bbl, we are seeing renewed pressure on the rupee. There has been extensive commentary on the trajectory of the rupee, especially as capital inflows have weakened materially.

This raises a broader policy question: is India implicitly prioritising export competitiveness over capital attraction through its exchange-rate stance?

A recent observation by former RBI Deputy Governor Michael Patra that rupee tends to depreciate by 4–5% annually warrants closer scrutiny. His recent work on exchange-rate policy has been an important contribution to understanding the RBI’s external management framework, but this particular observation raises questions for policy consistency.

The Indian rupee does not, in fact, depreciate at 5% annually over the long term. The historical average depreciation against the US dollar is closer to 3%, even after accounting for the stronger-dollar cycle over the past decade.

Against this backdrop, an implicit acceptance of 4–5% annual depreciation appears difficult to justify, particularly when viewed through the lens of India’s inflation-targeting framework.

This is especially relevant given that Michael Debabrata Patra was closely associated with the adoption of inflation targeting, one of the most significant financial reforms in India.

The logic of targeting Consumer Price Inflation at 4% was to provide a clear nominal anchor, reduce volatility, and deliver positive real interest rates over the cycle. As inflation and interest rate differentials with advanced economies narrow, the implied equilibrium rate of currency depreciation should also moderate.

In principle, this would suggest that rupee depreciation need not exceed the inflation differential, roughly 2% when comparing India’s 4% CPI target with US core inflation near 2%.

Yet, policy signalling has not reflected this framework with sufficient clarity. Two possible explanations emerge.

One relates to the objective of building foreign exchange reserves towards $1 trillion, as articulated by Michael Debabrata Patra. This estimate broadly reflects coverage of short-term external debt of about $300 billion and foreign portfolio equity exposure of roughly $700 billion.

Given that reserve accumulation requires capital inflows to exceed the current account deficit, and that this condition has held for much of the past three decades, the RBI has built reserves through sustained market intervention. This raises the possibility that reserve accumulation has, at times, been accompanied by a tolerance for a weaker rupee than fundamentals would justify.

Exports Vs Capital

A second, more structural explanation lies in India’s long-standing preference for export competitiveness. The long-held belief in Indian policy circles is that a weaker Indian rupee will boost exports. If so, is this policy translating towards creating policy space for ‘annual depreciation of 4-5%?

This is not to suggest that the rupee cannot depreciate by 4–5% annually. Rather, the currency reflects the broader policy environment in which it operates, including the quality of inflation management by the RBI and the coherence of tax and regulatory frameworks set by the government.

Even if pursued as policy, a 5% annual depreciation offers no assurance of export gains. India’s non-oil goods exports, despite targeted incentives and currency weakness, have struggled to gain a meaningful global share.

However, a 5% annual depreciation is certain to dissuade foreign savings from being invested in the Indian economy.

India must decide what its priority is. Especially in today’s changed world.

The global backdrop has shifted materially from the past two decades. Trade openness is no longer a given, and export-led strategies face increasing constraints. India is unlikely to secure preferential access or sustained external demand to drive export growth.

Global capital, however, remains mobile and is actively seeking diversification. It is heavily concentrated in the US and constrained in its ability to deploy meaningfully in China and several other markets due to geopolitical and structural risks.

This creates a narrow but significant opportunity for countries that can offer scale, stability and policy credibility. India is among the few ‘friendly’ economies positioned to absorb large, long-term capital flows.

Yet, the domestic policy framework continues to impose frictions, through tax uncertainty, retrospective actions, and an uneven regulatory environment, which raise the cost of investing in India.

Even where investors are willing to look past these constraints to access the India opportunity, a policy tolerance for sustained currency depreciation further erodes returns, compounding the deterrent to long-term capital allocation.

Take the simple case of Indian public equities.

(This is only for representation)

For a global investor, returns are evaluated in dollar terms, not rupees. Once tax and currency depreciation are incorporated, headline returns compress sharply.

In fixed income, we have a 20% withholding tax on interest income. In infrastructure, certain investors have tax exemptions, but most are taxed.

Why should global investors accept this combination of tax drag and currency loss?

As a result, global capital has simply raised the return threshold it demands from India, both to offset tax frictions and to protect itself against expected currency weakness.

Since the reintroduction of capital gains tax in 2018, foreign portfolio investment in Indian equities has remained modest, cumulatively under $20 billion, despite India being a roughly $4 trillion market capitalisation and GDP economy.

The explanation is straightforward. Global investors do not look at rupee returns in isolation. They assess post-tax returns in dollar terms. A 5% annual rupee depreciation assumption materially erodes what may otherwise appear to be attractive local-market gains.

OECD nations follow residence based taxation. India needs to do the same and scrap capital gains tax on foreign investors.

If capital gains were to be scrapped to reduce the tax burden and a policy signal is sent to prioritise global capital over global trade, the required return on India allocations could fall by 3–4%.

In global investing, that is a meaningful shift. An improvement of 3–4% in expected annual returns can alter capital allocation decisions at scale and, over time, mean the difference between marginal flows and hundreds of billions of dollars in investment.

For an economy with India’s financing needs, this is not a secondary issue. It goes to the heart of whether policy intends to privilege export competitiveness through a weaker currency or attract long-term foreign capital through more stable returns.

* The views and opinions expressed in this article are personal and should not be construed to be those of Q India (UK) Ltd.