The rupee’s dramatic fall against the US dollar from ₹90.95 on February 27 to ₹94.94 on May 4 translates into a -4.5% change in Indian currency’s value over a span of 65 days. This is attributed to the ongoing war in West Asia leading to disruptions in the supply of crude oil and subsequent rise in crude prices.
Even while the uncertainty over the war persists, the rise in foreign institutional investor outflows aided by the negative risk perception put downward pressure on the rupee value, prompting the Reserve Bank of India’s intervention to stem this fall.
The question is whether the rupee depreciation is triggered by the ongoing war or are there structural issues that need a reckoning. The exchange-rate dynamics provide a perspective on the underlying factors determining rupee depreciation.
1 May 2026
Get the latest issue of Outlook Business
The rupee’s demand and supply in the foreign exchange (forex) market are derived from trade and capital flows. Exports of goods and services drive rupee’s demand while the imports drive supply. In this demand-supply framework, exchange rate is the price of the rupee.
A stable exchange rate implies rupee’s demand is matched by its supply wherein exports equal imports or when ‘exports finance imports’. If exports rise relative to imports, demand exceeds supply and the price of rupee increases with exchange rate appreciation. Similarly, if imports rise relative to exports, supply exceeds demand and the price of rupee falls with exchange rate depreciation.
These exchange-rate dynamics are captured in India’s transactions with the world that are summarised in the balance of payments (BoP) under two accounts—current and capital.
Components Factor
While the current account summarises India’s trade in goods and services, the capital account records the net capital borrowings (capital inflows adjusted for capital outflows).
Thus, if a deficit in the current account is adjusted against the surplus in the capital account then it would mean: (i) exports of goods are lower than imports; (ii) net services exports are inadequate to bridge this trade deficit; (iii) if net capital surplus is mainly on account of capital borrowings (remittances, external commercial borrowings) then financing current-account deficit (CAD) would be unsustainable; (iv) if net capital surplus is on account of foreign direct investment/foreign investments that enhances the domestic production capacity/exports, then financing CAD is a sustainable option.
Against this framework, the significant rise in CAD from 2017–18 onwards (except 2021–22) necessitates a serious introspection.
A closer look at the components of current account points to a growing trade deficit, which has increased from $160bn in 2017–18 to $286.9bn in 2024–25 and $156.3bn in April-September 2025–26. During the same period, the net services exports (after adjusting interest cost) increased from $111bn to $263.9bn.
As such, CAD at $48.7bn in 2017–18 settled at $23bn in 2024–25. Therefore, addressing CAD necessarily points to reducing the trade deficit by increasing exports.
Given this, the rupee-depreciation shock raises the domestic prices of imports, triggering inflationary pressures and macro-economic instability. Thus, appreciation reduces domestic import prices while depreciation reduces foreign prices for domestic goods, thereby promoting exports.
However, in the Indian context, exports’ positive response to rupee depreciation is not supported by evidence. Here, it is important to recognise the strong correlation between stability in exchange rate and lower CAD as evident in the BoP trends.
In 2023–24, robust exports coupled with rise in net service exports earnings resulted in a decline in CAD and brought in stability to the exchange rate. The average exchange rate remained stable at ₹82.79. The implications are clear: export growth can arrest currency depreciation.
But how do we increase and sustain export growth?
Exports Structure
The relationship between export price, exchange rate and export growth is not linear and depends on the structure of export composition and corresponding export-price elasticity. Shifts in exchange rate affect the export and import prices and determines domestic prices.
For example, with rupee depreciation against the dollar from ₹84.58 in 2024–25 to ₹94.85 in 2025–26, every dollar spent can purchase more rupee-denominated goods. This will be true if the exchange rate is reflected fully in the domestic prices, referred to as Exchange Rate Pass Through (ERPT). The ERPT varies across products and markets. In highly competitive markets such as commodities or low-value products, the market structure is competitive, price elasticity is high and therefore ERPT will be close to complete. For high value and differentiated products, the price elasticity is low and ERPT will be incomplete.
These dynamics of exchange rate movement and export pricing are captured by the estimates of export price elasticities of India’s major exports.
These export price elasticities provide two interesting insights. First, for exports of technology intensive products like chemicals (pharmaceuticals) and transport, the elasticities are low. This implies that the exchange rate movements have limited effect on the prices of these products.
Second, low-technology products like textiles and metals have higher elasticities, implying a stronger effect of exchange rate movements on the exports of these products. And, considering a high share of textiles and metals in India’s total export basket at over 30%, India’s exposure to exchange rate movements is significant.
These elasticities can change over time depending on the product complexity induced by technology factors. So, it is imperative that the structural composition of exports need to shift towards technology intensive and high value products. India needs to build a high growth trajectory for such exports to counter geopolitical shocks and limit adverse effects of exchange rate movements.
The need to pursue this structural shift has been amply underlined with targeted industrial policies and technological upgrades. But this potential remains largely unrealised.
(The writer is professor, Indian Institute of Foreign Trade, New Delhi, and an international trade expert)
