The Indian rupee has emerged as Asia's worst-performing currency in 2025, depreciating 5.54% year-over-year and breaching the critical 90 per dollar mark in early December. This represents a dramatic reversal from the rupee's historical stability and reflects a shift in India's external dynamics. The rupee now trades at the 80th percentile of global currency performance, underperforming not only commodity-linked currencies but also key Asian peers including the Chinese Yuan (+2.17%) and Brazilian Real (+11.74%).

The weakness stems from three interconnected factors: elevated US tariffs (50%) on Indian exports, a merchandise trade deficit exceeding $42 billion monthly, and temporary FPI outflows of $16-18 billion. However, structural buffers remain intact—forex reserves of $686 billion (11 months of import cover), net FDI improvements to $7.64 billion in H1 FY26 (double prior-year), and record gross FDI inflows of $50.36 billion. RBI Governor Sanjay Malhotra's December 2025 policy framework embraces greater exchange rate flexibility, positioning the rupee as an automatic stabilizer rather than a fixed anchor. Market consensus expects the rupee to trade in the 86-91 per dollar range through 2026, with the India-US trade deal serving as the critical binary catalyst.

The rupee's 2025 underperformance—while significant at the bottom quartile of its peers—reflects India-specific tariff impacts and temporary capital rotation rather than systemic vulnerability. As US-India trade tensions resolve and FPI underweight positions correct, market consensus anticipates gradual rupee recovery toward mid-80s through 2026, restoring India's historical position as a relatively stable currency with strong institutional backing and robust capital inflows.

The -4.33% six-month decline reveals accelerating depreciation pressure concentrated in recent months. During H2 2025, the rupee breached 90 per dollar for the first time—an unprecedented milestone that, while orderly in execution, signals heightened external vulnerability. The rupee fared marginally better than only the Japanese Yen (-7.53%) and Korean Won (-6.18%), both facing structural headwinds from US-China trade tensions. Over the past 12 months, the rupee's -5.54% decline positions it firmly in the bottom quartile of the EM currency basket, significantly worse than the Global average of 2.64% and median of 0.19%. This marks the rupee's poorest one-year performance since 2022-23.

Performance Relative to Asian and BRICs

The -4.33% six-month decline reveals accelerating depreciation pressure concentrated in recent months. During H2 2025, the rupee breached 90 per dollar for the first time—an unprecedented milestone that, while orderly in execution, signals heightened external vulnerability. The rupee fared marginally better than only the Japanese Yen (-7.53%) and Korean Won (-6.18%), both facing structural headwinds from US-China trade tensions. Over the past 12 months, the rupee's -5.54% decline positions it firmly in the bottom quartile of the EM currency basket, significantly worse than the Global average of 2.64% and median of 0.19%. This marks the rupee's poorest one-year performance since 2022-23.

Structural Drivers: Trade Deficit and Capital Dynamics

Trade Deficit Expansion: India's merchandise trade deficit surged to $41.7-42 billion in October 2025, remaining consistently above $30 billion for consecutive months—a dramatic reversal from the compressed current account balances of 2023-2024. This deterioration reflects:

US Tariff Impact: The 50% tariff on Indian exports (imposed August 2025) has severely damaged export competitiveness. While non-US markets showed resilience through September, October data revealed exports were falling to both US and rest-of-world destinations.

Elevated Import Demand: Domestic capital expenditure and energy requirements continue driving import growth, widening the deficit despite tariff-induced import substitution.

Experts forecasts project India's current account deficit expanding to 1.4% of GDP in FY26 from just 0.6% previously—a six-fold deterioration within a single fiscal year.

Capital Flows: Mixed but Improving

Contrary to crisis narratives, capital flows paint a more nuanced picture:

• Net FDI doubled to $7.64 billion in H1 FY26 (April-September 2025) from $3.4 billion prior year, driven by 16% gross FDI inflows growth to $50.36 billion
• US FDI inflows more than doubled to $6.62 billion despite tariff tensions, reflecting long-term investor confidence
• Outward FDI accelerated to $16.32 billion as Indian corporations leverage liberalized ODI rules and global profitability gains
• FPI equity outflows of $16-18 billion reflect temporary valuation rotation rather than structural exit, as India's MSCI index underperformed broader EM (2.5% vs 27.7% dollar returns)

The September 2025 monthly net FDI of -$2.37 billion represents temporary lumpy repatriation rather than structural capital flight.

RBI Policy Framework and Market Expectations

New Regime: Market-Driven Flexibility

RBI Governor Sanjay Malhotra's December 4, 2025, policy statement marked a watershed: "We don't target any specific price levels or bands...We let markets function...We just let the rupee find its correct position." This represents explicit abandonment of the prior 80-84 band defense. While RBI sold $400 billion in FY 2024-25, interventions fell sharply to $21.7 billion in H1 FY 2025-26, confirming the policy shift. The Governor noted that a 5%-rupee depreciation adds 35 bps to inflation and subtracts 25 bps from GDP— impacts already embedded in RBI's revised 2.0% inflation and 7.3% growth forecasts for FY26.

Market Consensus: Trade Deal as Binary Catalyst

Baseline scenario: India-US trade deal by Q1 2026 reducing tariffs to ~25%, stabilizing rupee at 88-91 through end-2026, with gradual recovery to 86.5-87.5 by end-2026 as capital flows normalize. Downside scenario: Failed trade negotiations force rupee testing 92-95 per dollar through 2026 as trade deficits persist.