After a bruising 2025, can India’s rupee find its footing next year?

Mumbai: After plummeting over 6% in 2025 and breaching the psychologically-important 90-per-dollar mark, the Indian rupee is heading into 2026 carrying the weight of weak capital flows, global trade uncertainty and shifting central bank strategy.

Yet, beneath the headline depreciation, economists and market participants said the outlook for the currency next year is far from one-way depreciation and hinges crucially on how the external sector evolves, especially India's trade deal with the US.

At the heart of the debate is whether this year's weakness marks the start of a more prolonged downcycle or a painful, but necessary adjustment.

“Typically, the rupee needs to depreciate to the extent of the interest rate differential between the US and India, but the reality is that the external front has been hit hard by US tariffs," Neeraj Gambhir, executive firector at Axis Bank said. "Therefore, the outlook for next year is significantly dependent on the outcome of tariff discussions."

Two paths for 2026

In an optimistic scenario, clarity on tariffs between India and the US by early 2026 could help reverse export losses, draw back equity investors, and lift sentiment around India.

“If all these things materialize, you will potentially end up seeing either no depreciation or a very mild depreciation in the rupee next year," Gambhir said, adding that the currency could hover around current levels of 90-91 to the dollar in such a case.

The pessimistic scenario is less forgiving. If trade negotiations falter and external pressures persist, markets should brace for “another 3-4% depreciation", potentially pushing the rupee closer to 95 to a dollar, Gambhir said.

In August, the US slapped 50% tariffs on Indian goods. Since then, Indian exports have weakened as the country is the biggest market for India and despite months of negotiations, there is yet no clarity on when a trade deal to bring down the tariffs would be signed.

Even in that scenario, Gambhir dismissed fears of a rapid slide to 100. “There’s still time. A 10% depreciation is a two-to-three-year phenomenon, not a one-year event."

Research backs up this conditional outlook. “In our base-case, we expect a trade deal to be reached in FY26, based on the positive statements by both governments. This will provide temporary relief to the INR but depreciation is expected to resume, albeit at a more moderate pace," IDFC FIRST Bank said in an outlook report on 17 December.

Seasonal factors will also support the Indian unit in January-March, when the trade deficit narrows and the balance of payments tends to be in a surplus. Indian rupee is expected to reach 88.50 against the greenback by March 2026 and at 89.50-90.00 by June 2026, the research report said.

The rupee had kicked off 2025 at 85.65 levels and has slid over 6% over the year, becoming the worst-performing currency in Asia, according to data by Bloomberg.

After hitting a fresh record low of 91.07 against the dollar on 18 December, the rupee ended at 89.65 on 19 December after the Reserve Bank of India (RBI) intervened through dollar sales in the local market. It had forcefully intervened on 17 December as well, leading to an intraday gain of 1% in the currency and has been intervening since then to protect the rupee from a further fall. The central bank’s move comes after the rupee tested a series of record lows in recent weeks.

On 26 December, the Indian unit had ended at 89.85 to a dollar.

Capital flows

If there was one theme that defined the rupee’s weakness in 2025, it was the relentless selling by foreign portfolio investors (FPIs). So far in 2025, FPIs have sold equities to the tune of ₹1.58 lakh crore, according to 26 December data from National Securities Depository Ltd.

“Well, I think, almost everyone will tell you that the currency weakness that we have experienced in the last few months is almost entirely because of the selling by FPI every day," Hitendra Dave, chief executive officer at HSBC India said in an interview earlier this month.

Large initial public offerings (IPOs) have exacerbated the pressure, as foreign investors exit positions to fund primary market investments and then repatriate the proceeds.

India’s traditional external financing mix has also shifted unfavourably. While the current account deficit remains modest, both FDI (foreign direct investments) and FPI flows have turned negative due to equity sales and portfolio outflows.

“Now, we have a current account deficit, and the FDI is also negative. FPI is negative because of equity sales," Dave said. In his theory, currency weakness becomes the market’s adjustment mechanism to prolonged capital outflows.

This view was also echoed by Bank of Baroda in its research report on 17 December, which said FPI flows have been among the most statistically significant drivers of month-to-month rupee movements, outweighing the trade deficit itself.

Fundamentals offer comfort

Not everyone sees reason for alarm. Axis Bank’s India Economic Outlook 2026 dated 10 December expects depreciation pressures to abate as growth strengthens and the real effective exchange rate becomes more competitive.

The report expects only ‘mild, not wild’ depreciation as the base case, with the current account deficit widening modestly but remaining manageable at around 1.2–1.3% of GDP.

RBI’s quieter hand

An important shift in 2025 has been the RBI’s tolerance for a weaker currency. With constraints arising from its forward book and the need to preserve domestic liquidity, the central bank has intervened more selectively.

Economists believe that this signals a structural change that the RBI is willing to accept gradual depreciation as long as it is orderly.

“RBI intervention pattern indicates a higher tolerance for INR depreciation this year with a more moderate pace of FX intervention. Gross dollar sales by RBI in FYTD26 (till November) is tracking at US$79 billion vs US$399 billion in FY25," the IDFC FIRST Bank research report said.

The more measured pace of selling reflects the limited ability of the RBI to use the forwards to sterilize spot intervention, the report said.

For 2026, that implies fewer attempts to ‘draw a line in the sand’ and a rupee that responds more freely to global forces, especially US monetary policy, trade dynamics and investor risk appetite.

So, where does the rupee land? Its path in 2026 will likely oscillate between stability and slow weakening, led by whether capital flows revive and trade uncertainty eases.