5 impact channels
BofA said the rupee’s weakness, close to 7% over the past year and even greater in real effective terms, is among the most pronounced in recent history, and its effects will filter through the economy through five transmission channels:1. Sentiment: Sharp exchange rate movements historically undermine confidence in the manufacturing and services sectors and increase perceptions of policy uncertainty, which often feeds into asset prices.
2. Growth: Imports respond first to depreciation and shrink as costs rise. Exports improve later and more modestly, with BofA noting that exchange rate sensitivity has weakened in recent years.
3. Inflation: Depreciation typically increases inflation through imported inputs, precious metals and intermediate goods, although BofA expects the impact to be mitigated by low crude oil and commodity prices.
4. External balances: Trade and services balances generally improve with some lag after the depreciation, even as uncertainties surrounding the US-India trade deal limit export gains in the short term.5. Fiscal Finances: Higher subsidy expenditure, especially on LPG and fertilisers, could put pressure on the budget, while the RBI’s higher foreign exchange earnings from intervention could boost dividends, leaving the net fiscal outturn ‘unclear’.
The rupee’s weakness is among the steepest since previous crisis periods
Comparing the currency’s decline to previous downturns in 2008, 2013 and 2018, BofA noted that the rupee has fallen 8.6% in REER terms over the past year and more than 12% over the past year, a magnitude rarely seen outside major stress periods.
This setback comes against the backdrop of disparate asset performance: the Nifty 50 is up more than 9% this year, while India lags the 25% rally in MSCI’s Asia ex-Japan index.
BofA said the latest phase of depreciation “may persist in the near term,” citing uncertainty over the US-India trade deal and pressure on capital flows.
Capital flows are under pressure
The current account deficit remains contained, helped by crude oil at $60 to $65 per barrel and resilient exports of services and remittances. But capital flows are ‘the main challenge’.
FDI, FPI and debt inflows have slowed significantly. Between October 2024 and September 2025, the RBI sold $65 billion in the spot market and has a short forward position of $63.6 billion, which is likely to have been expanded further in November as pressure mounted.
According to BofA, “continued portfolio outflows could make these operations unsustainable, or RBI’s build-up of short USD positions could distort INR return expectations.”
Strategists still see a moderate valuation next year
Despite the tension, BofA currency strategists expect USD weakness to support the INR’s gradual rise in 2026. They predict the rupee will reach 86 per dollar by the end of 2026 if the trade deal is finalized and stock market sentiment stabilizes.
They said a revival in India’s growth momentum would support corporate earnings and ease valuation pressures that have contributed to this year’s equity outflows.
BofA expects the RBI to remain active in both the spot and forward markets, noting that the governor has reiterated that the central bank’s tolerance for currency volatility “has not changed.” The RBI is likely to soften the pace of depreciation rather than defending a specific level, while opportunistically rebuilding reserves as inflows return.
While the typical pass-through is ~35 basis points of inflation for every 5% of REER weakness, BofA said the impact will likely be softer in 2026:
Crude oil is cheaper in INR terms than it was in early 2025.
High fuel prices in India are helping oil companies maintain fat marketing margins, reducing the need for retail increases.
Entrenched disinflation in China continues to suppress input cost pressures.
Inflationary pressures may still exist in precious metals and some intermediate products.
External balances may improve in the coming quarters
Depreciation tends to strengthen India’s services balance, which improves by 0.8% for every 1% of currency weakness, according to RBI research cited by BofA, and typically boosts remittances once the rupee stabilizes.
The improvement in the trade balance may be slower this time around due to uncertainty over tariffs, but BofA still expects overall current account pressures to ease over the next three to six months.
A weaker rupee may push up fertilizer and LPG subsidy costs, but the RBI’s heavy currency intervention means foreign exchange earnings and revaluation balances could rise.
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That could translate into a higher RBI dividend in FY27, which could ease fiscal pressure.
Despite a robust year for domestic equities, the rupee remains Asia’s worst performer, a position that highlights the depth of the five-channel shock that BofA says is now in motion.
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