Economists predict short-term impact of rupee depreciation, but border tensions may worsen impact

New Delhi: Economists expect the impact of the Indian rupee’s sharp drop against the US dollar to be short-lived, despite concerns over inflation, foreign investment, and fiscal stability, as escalating India-Pakistan tensions, a strengthening US dollar, and a market sell-off drive the currency’s decline. At the same time, they warned that things could take a turn for the worse if the conflict with Pakistan lingers.

The rupee’s 88-paise drop on Thursday marked its steepest single-day fall in more than two-and-a-half years. On Friday, it opened 0.2% lower at 85.85 against the US dollar, and thereafter depreciated 15 paise to 85.869 in early trade. In comparison, the rupee stood at 83.51 against the dollar a year ago (9 May 2024), according to Bloomberg data.

“The rupee is echoing the turmoil in the political space, as well as the limited gains made by the dollar,” said Madan Sabnavis, chief economist at the Bank of Baroda. “This will continue until the situation stabilises. The dollar can strengthen as agreements are reached on tariffs with other countries.”

Sabnavis noted that while a falling rupee may slightly increase import costs, weaker global commodity prices—particularly oil—should help offset this effect. “Investors would compare this with changes in other countries, but the impact is more of a short-term nature,” he added.

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The currency’s sharp decline is linked to the latest flare-up in India-Pakistan tensions that followed from a terrorist attack in Kashmir’s Pahalgam. Tensions have since escalated with India targeting terror infrastructure in Pakistan, after which both countries have been targeting each other’s military facilities in different locations. 

All good, but…

According to Debopam Chaudhuri, chief economist at Piramal Enterprises Ltd, the rupee’s depreciation against the US dollar is driven by a stronger dollar that has been boosted by optimism over US-China tariff talks, and rising India-Pakistan tensions.

“Despite these dual pressures, USD-INR has so far held above its record low of 87, last seen in March 2025,” said Chaudhuri, adding that this would suggest the weakness in the rupee is temporary, provided the military situation stabilizes. “However, if the conflict escalates further, the USD-INR could once again fall to 87 or below in the near term,” he added.

In a report on Friday, Bajaj Broking Research said a short-term geopolitical crisis could disrupt investor sentiment and slow economic activity.

“However, India’s structural growth drivers—such as domestic consumption, digital transformation, and policy reforms—are likely to sustain momentum,” it said. “Unless prolonged instability affects key sectors, any setback would be temporary rather than a derailment of India's long-term trajectory.”

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Abhay Tilak, director and secretary, Institute of Political Economy, said there needs to be constant monitoring of the cost of any expenses incurred in military exercises. “If the current situation escalates to a full-blown war, the impact on the fiscal deficit as well as the current account deficit would be immense,” he said. “Due to the depreciated rupee, the import bill will swell and in the face of dismal scenario on the export front, it will eventually lead to widening of the current account deficit.”

Tilak added that the colloquial theory of exports benefiting out of rupee depreciation is unlikely to be followed in the current scenario. “That is because of the global shift towards protectionist measures. Exports simply have not attracted enough demand,” he said.

Earlier this week, ratings agency Moody’s said that India’s macroeconomic stability may hold firm even if tensions with Pakistan escalate, citing India's minimal economic relations with Pakistan. “However, higher defence spending would potentially weigh on India's fiscal strength and slow its fiscal consolidation,” the ratings firm had said.

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To be sure, the Pakistani Rupee's exchange value against the US dollar depreciated to ₹281.15 on 9 May from ₹278.04 a year ago (10 May 2024).

Rising tensions

Diplomatic ties between the two nations have deteriorated sharply since the Pahalgam massacre, where tourists were gunned down by terrorists. Following this, India suspended the 1960 Indus Waters Treaty, prompting Pakistan to scrap the 1972 Simla Agreement and close its airspace to Indian carriers. 

Thereafter, India struck terror infrastructure in nine cities in Pakistan and Pakistan-occupied Kashmir under Operation Sindoor, which were “focused, measured and non-escalatory”, the defence ministry has maintained.

According to the Indian Army, Pakistan's armed forces launched multiple drone and artillery attacks along the western border on the night of May 8-9, which were “effectively repulsed”. 

Pakistani troops have also carried out numerous ceasefire violations along the Line of Control in Jammu and Kashmir, the Army said. However, despite strong rhetoric from both sides and a wider military confrontation, the conflict has yet to escalate into a full-scale war.

India and Pakistan, both nuclear-armed, have fought four wars—in 1947, 1965, 1971, and 1999—mostly over the disputed Kashmir region.

The latest flare-up marks another chapter in their long history of recurring confrontations.

Manas Pimpalkhare in New Delhi contributed to this story.

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