The rupee has surpassed the 90 per dollar mark, down over 5% from the start of 2025. While the exchange rate has depreciated quite a bit this year, the most recent trigger was the 12% year-on-year contraction in exports for the month of October, driven mainly by a decline in exports to the US. Markets are spooked by fears that high tariffs have started hurting shipments to India’s largest export market.
The good news is that a weaker rupee makes Indian exports cheaper in dollar terms, which offsets some of the damage caused by US tariffs. Even better, this time, the falling nominal exchange rate has been accompanied by falling inflation differentials between India and the US. Consumer price inflation in India has dropped to sub-1% levels, while US inflation appears to have stabilized at 2-3%. That’s a double boost for exports: prices are lower in India, and its currency is weaker. The result is that for an American buyer, a basket of Indian goods is cheaper than before. For Indians, though, it costs more to buy a basket of American goods.
In other words, the rupee is undervalued against the dollar in real terms. “Real undervaluation” means that the loss of value for the rupee is the result of both nominal depreciation and relative prices.
An undervalued real exchange rate makes Indian exports more competitive in real terms, but it also makes imports more expensive. Since India trades with many countries, it is useful to look at multi-currency real effective exchange rates (REER) estimated by the Reserve Bank of India—in fact, they also show undervaluation.
Entwined trade
It is important to assess the impact of changes in the real exchange rate on both exports and imports for two reasons. First, exports and imports are closely entwined in global trade. It is estimated that about 70% of international trade passes through global value chains (GVCs), where goods and services move to and fro across borders for value addition, before the final product is shipped to customers. India is not as entrenched in GVCs as some export-oriented economies, but it relies hugely on imported raw materials and intermediate goods.
A recent study by EXIM bank showed that in 2022-23, the import intensity for raw materials for the overall manufacturing sector was 33.4%, and it was much higher for top export-oriented industries such as gems and jewellery (68.4%), electronics (64%), and chemicals (63%). For these sectors, the additional competitiveness gained from a nominal depreciation gets offset to varying degrees by the higher cost of imported inputs.
Second, India is heavily dependent on China for imports of key industrial materials. A mapping of imports by commodity categories shows the extent of this dependence: of the top fifteen categories of imports, China dominates or is a significant supplier in ten categories. Fortunately for Indian importers, China is in the midst of a prolonged deflation, and lower prices of Chinese goods mitigate the impact of a weaker rupee to some extent.
Cheapflation threat
But this dynamic works in reverse for Indian domestic manufacturers, who are at a disadvantage to overseas low-cost producers, especially if their lower prices outweigh the impact of a weaker rupee. For example, between January 2024 and October 2025, average inflation in China was about 0.04%, while India’s CPI inflation averaged at a much higher 4%. Thus, though the rupee depreciated against the yuan in nominal terms, it would have still been cheaper to import from China than to produce locally.
In addition, owing to large surplus capacities and weak domestic demand, Chinese producers are reported to be dumping goods at below-market rates. The recent suggestion to impose “safeguard duties” on Chinese steel products is a by-product of these developments.
Currency constraints
The relationship between the real exchange rate and exports is complex and nuanced. A World Bank study found that the positive impact of an undervalued real exchange rate on exports disappears when a firm imports more than 30% of its intermediate inputs. The aforementioned EXIM bank study confirmed a similar result for India’s import-intensive electronics sector.
In the 1970s, the Asian tigers relied on managed exchange rates to further their export-led growth strategy; clearly, that would not work today. To be sure, an undervalued real exchange rate may provide a one-time export stimulus, particularly if it is driven by a large nominal depreciation. But on a sustained basis, export competitiveness depends largely on world growth and productivity. Exports are more likely to boom when global growth is strong and domestic manufacturers are globally competitive.
India has recently taken some important steps to improve the ease of doing business. These include notifying major labour reforms, opening up parts of the financial sector to foreign capital, and easing the burden of taxation. Yet we have far to go: a widely tracked index of competitiveness ranks India at the 41st position out of 69 countries, highlighting inadequate infrastructure and government inefficiencies as the chief impediments to productivity.