RBI cautions against risks to economy even as fundamentals remain strong

Mumbai: Although the Indian economy remains resilient, with strong growth momentum, the Reserve Bank of India (RBI) on Wednesday flagged a cluster of risks that could disrupt financial stability.

External uncertainties, including further escalation in geopolitical and trade tensions and widening geoeconomic fragmentation, were the major risks highlighted by the central bank in its Financial Stability Report.

“They could lead to higher volatility in exchange rate, weaker trade, lower corporate earnings and muted foreign direct investments,” RBI said.

A strong depreciation in the rupee—it had started 2025 at 85.65 levels and slid by over 6% over the year—made it the worst-performing currency in Asia, according to data from Bloomberg.

According to the RBI report, the depreciation reflected falling terms of trade due to the impact of tariffs and slowdown in capital flows. The RBI was referring to US President Donald Trump’s 50% tariff on Indian goods shipped to the US.

It said that with the effective US tariff rate on India being the highest compared to its trading partners, the rupee depreciated despite the broad weakening of the dollar against other major and Asian currencies.

“Importantly, the exchange rate has displayed (a) wider trading range, which in turn has imparted higher volatility. Currency derivatives markets also point to the likelihood of increased volatility going forward as trade tensions continue to weigh on market sentiments,” it said.

The pressure on the currency was exacerbated by constant selling by foreign portfolio investors. Per data from NSDL, overseas investors were net sellers of $18.9 billion in the local equity market in 2025, as against net buyers of $124 million in equities in 2024.

Market corrections

The regulator also cautioned against a sudden and sharp correction in the US equity markets. Such a situation, it said, could cause a correction in domestic equities, affect investor confidence and wealth, trigger foreign portfolio outflows and tighten domestic financial conditions.

It said the Indian equity markets' performance has been modest compared to its emerging market peers this year, following a five-year period of outperformance since 2020.

According to the report, tepid corporate earnings growth amid relatively slow nominal GDP (gross domestic product) growth, higher valuations, sustained FPI outflows, adverse tariff outcomes, and depreciation in the rupee have weighed on the equity market.

However, in the face of these risks, the economy and the financial system have adequate buffers to withstand them, the report said. These include strong domestic growth drivers, sizeable foreign exchange reserves, and sufficient capital and liquidity buffers in the financial and corporate sectors.