Indian Rupee Performance 2025: Why the Currency Underperformed – Economic Survey 2025-26
Despite India recording its strongest macroeconomic performance in decades, the Indian rupee underperformed against the US dollar in 2025. The Economic Survey 2025-26 addresses this paradox directly, offering insights into why currency strength does not automatically follow economic strength and what structural factors drive currency dynamics. This article examines the rupee's performance and its implications for economic policy.
The Paradox: Strong Economy, Weak Currency
The Economic Survey 2025-26 articulates a puzzling situation: "The paradox of 2025 is that India's strongest macroeconomic performance in decades has collided with a global system that no longer rewards macroeconomic success with currency stability, capital inflows, or strategic insulation."
The survey lists India's positives: Growth is strong, the outlook is favorable, inflation is contained, rainfall and agricultural prospects are supportive, external liabilities are low, banks are healthy, liquidity conditions are comfortable, credit growth is respectable, corporate balance sheets are strong, and policy dynamism is evident.
Yet, the survey concludes: "The rupee's valuation does not accurately reflect India's stellar economic fundamentals. In other words, the rupee, therefore, is punching below its weight."
Structural Explanation: Trade Deficits and Capital Dependence
The survey provides a structural explanation for the rupee's underperformance rooted in India's external sector dynamics.
"India runs a trade deficit in goods. Its net trade surplus in services and remittances is not enough to offset it. India depends on foreign capital flows to maintain a healthy balance of payments. When they run drier, rupee stability becomes a casualty."
This creates a fundamental vulnerability. No matter how strong domestic fundamentals are, the rupee's strength depends on foreign investors' willingness to bring capital into India. Global factors affecting this willingness – US interest rates, global risk appetite, geopolitical tensions – can move the rupee regardless of domestic performance.
Manufacturing Exports: The Missing Ingredient
The Economic Survey 2025-26 draws an important link between currency stability and manufacturing exports. "Currency strength, in general, or currency stability during crises, has always eluded countries that could not become successful and significant exporters of manufactured goods. Countries with strong, stable currencies are known for their manufacturing excellence."
This observation is supported by international experience. Germany, Japan, South Korea, and China – all known for strong currencies or managed stability – are manufacturing powerhouses. Their export surpluses generate foreign currency earnings that support their currencies without depending on capital inflows.
India's services exports, while substantial, have not provided the same currency support. The survey notes that over five years, services exports grew at 9.4 per cent CAGR while merchandise exports grew at only 6.4 per cent. Services have compensated for weak goods exports but cannot substitute for them in terms of currency dynamics.
Global Context: A Changed System
The survey places rupee performance within a broader global context. The traditional assumption that sound macroeconomic policies would be rewarded with currency stability and capital inflows no longer holds reliably.
Global trade is increasingly fragmented along geopolitical lines. Capital flows are influenced by security considerations alongside economic ones. The US dollar's role as the dominant reserve currency means that Federal Reserve policy affects emerging market currencies regardless of their domestic fundamentals.
In this environment, even well-managed economies can face currency pressure. India is not alone in experiencing this disconnect between fundamentals and currency performance.
Implications of Currency Weakness
The survey takes a nuanced view of rupee underperformance. "It does not hurt to have an undervalued rupee in these times, as it offsets to some extent the impact of higher American tariffs on Indian goods, and there is no threat of higher inflation from higher-priced crude oil imports now."
A weaker rupee makes Indian exports more competitive – helpful when facing US tariffs. It also makes imports more expensive, potentially supporting domestic manufacturing (import substitution).
"However, it does cause investors to pause. Investor reluctance to commit to India warrants examination."
Foreign investors, particularly portfolio investors, factor currency returns into their investment decisions. Expected rupee depreciation reduces the attractiveness of rupee-denominated assets, potentially reducing capital flows that India needs to finance its current account deficit.
The Power Gap Index
The Economic Survey 2025-26 references the Australia-based Lowy Institute's Power Gap Index, which suggests that India is operating below its full strategic potential. India's power gap score is -4.0, the lowest in Asia excluding Russia and North Korea.
While this index measures strategic power broadly rather than currency specifically, the connection is important. Currency strength is an element of national power. A country that cannot maintain currency stability during crises has less room for independent economic policy.
Policy Implications
The survey's analysis leads to clear policy implications:
Manufacturing Push: Boosting manufactured exports is essential for durable currency stability. PLI schemes, trade agreements, and infrastructure development all support this objective.
Export Earnings Focus: India needs to "generate sufficient investor interest and export earnings in foreign currency to cover its rising import bill."
Reducing Import Dependence: The survey notes that regardless of indigenization success, rising incomes will bring rising imports. This reality requires persistent efforts to boost export earnings.
Buffer Building: Maintaining adequate foreign exchange reserves provides a buffer against capital flow volatility.
UPSC Relevance: Exchange Rate
Exchange rate dynamics are crucial for UPSC:
- GS-III: External sector, currency, trade
- Economy: Balance of payments, exchange rate determination
- Current Affairs: Rupee movements, RBI intervention
Practice MCQs on Indian Rupee - Economic Survey 2025-26
Q1. According to Economic Survey 2025-26, the rupee in 2025:
(a) Appreciated significantly
(b) Underperformed despite strong fundamentals
(c) Was fully stable
(d) Strengthened against all currencies
Answer: (b) Underperformed despite strong fundamentals
Q2. The survey describes the rupee as:
(a) Punching above its weight
(b) Fairly valued
(c) Punching below its weight
(d) Overvalued
Answer: (c) Punching below its weight
Q3. According to Economic Survey 2025-26, countries with strong currencies are typically known for:
(a) Large services exports
(b) Manufacturing excellence
(c) Tourism dominance
(d) Natural resource exports
Answer: (b) Manufacturing excellence
Q4. India's currency stability depends on foreign capital because:
(a) India has no domestic savings
(b) India runs a trade surplus
(c) India runs a trade deficit in goods
(d) India has no foreign exchange reserves
Answer: (c) India runs a trade deficit in goods
Q5. According to Economic Survey 2025-26, a weaker rupee can help offset:
(a) Domestic inflation
(b) Impact of US tariffs on Indian exports
(c) Budget deficit
(d) Public debt
Answer: (b) Impact of US tariffs on Indian exports
Conclusion
The rupee's performance in 2025, as analyzed in the Economic Survey 2025-26, illustrates that currency dynamics are driven by structural factors beyond immediate economic fundamentals. While India's economy has performed exceptionally well, the rupee's weakness reflects dependence on capital flows to finance the trade deficit and the absence of strong manufacturing exports that historically underpin currency strength. Addressing this requires sustained focus on building manufacturing competitiveness and export capacity – a theme that runs through the survey's broader economic strategy.