Rupee@97: Decoding the drivers of the Indian currency’s long-term slide

The Indian rupee plunged to a record low of 96.97 intra-day before settling at 96.82 against the United States dollar amid a sharp rise in foreign capital outflows from domestic equity markets, as foreign portfolio investors (FPIs) accelerated selling activity. The steep decline has made the rupee Asia’s worst-performing major currency in recent months. The depreciation has largely been driven by surging global crude oil prices, intensifying geopolitical tensions in West Asia, and aggressive sell-offs by foreign institutional investors (FIIs), all of which have heightened pressure on India’s external balances and currency markets.

According to Madan Sabnavis, the rupee’s approach towards the Rs 97 per US dollar mark has shifted market focus towards the currency’s future trajectory and the pace of depreciation. He noted that the rupee had remained relatively stable during the latter half of February, prior to the escalation of the US-Israel conflict involving Iran on February 28, before beginning to weaken steadily from March 2 onwards. While the movement has not followed a fixed pattern, the currency has displayed a gradual upward drift in the dollar-rupee exchange rate between March 2 and May 19. Sabnavis observed that the annualised average daily volatility in the rupee stood at 6.7 percent during the period.

Data on the rupee’s trading pattern also indicates that five trading sessions have emerged as the most stable extended period for the currency within a one-rupee band. The rupee remained in the Rs 92–93 range for five consecutive days, followed by four days in the Rs 93–94 band before moving in either direction. Similarly, the currency stayed within the Rs 94–95 and Rs 95–96 ranges for five sessions each before breaking out of those levels. In the case of the Rs 94–95 band, the rupee initially weakened further before briefly recovering for two sessions. More recently, the currency has moved into the Rs 96–97 range, where it has remained for three consecutive trading sessions, including May 20.



Key triggers
In theory, the rupee’s movement is largely influenced by changes in macroeconomic fundamentals governing the inflow and outflow of dollars in the domestic market. Among the most significant indicators are foreign portfolio investment (FPI) flows, which are available on a daily basis and provide a direct gauge of overseas investor sentiment towards Indian assets. Global crude oil prices, particularly Brent crude, also play a crucial role given India’s heavy dependence on energy imports.

In addition, geopolitical developments — especially war-related announcements affecting crude oil markets — have had a notable impact on both the rupee and global risk sentiment. Movements in the US dollar index, which measures the greenback’s strength against major global currencies, along with indications of ex-ante intervention by the Reserve Bank of India (RBI) based on market feedback, have also shaped currency trends.

To identify the factors that have statistically exerted the strongest influence on the rupee, a series of regression analyses were conducted. The study mapped daily changes in the exchange rate against multiple variables, including same-day and one-day lagged FPI flows, changes in Brent crude prices in dollar terms, and percentage changes in the US dollar index along with its one-day lag effect. The regression exercises primarily examined the movement in the RBI reference rate in percentage terms against these variables to determine the best statistical fit and establish the dominant drivers behind the rupee’s recent depreciation trend.

Variable factors
The three variables included in the regression model together account for nearly 25 percent of the variation in the rupee-dollar exchange rate, indicating that roughly one-fourth of the currency’s movement can be explained by these independent factors. The findings suggest that changes in crude oil prices have a direct and statistically significant impact on the rupee. This influence operates both through India’s import bill, which rises with higher oil prices, and through market sentiment, where sharp increases in crude trigger an immediate psychological reaction in currency markets.

Interestingly, the analysis showed that same-day foreign portfolio investment (FPI) flows had a positive relationship with the movement in the exchange rate, implying that higher inflows were associated with rupee depreciation — a result that runs contrary to conventional economic theory. This anomaly could partly be attributed to settlement-related lags in pay-ins and pay-outs. However, when previous-day FPI flows were incorporated into the model, the relationship aligned with conventional expectations, with inflows supporting rupee appreciation and outflows contributing to depreciation. Both variables were found to carry statistically significant coefficients.

The study also revealed that movements in the US dollar index did not exert a statistically meaningful influence on the regression results and were therefore excluded from the final model. In fact, including the dollar index weakened the overall relationship, with only a marginal improvement in the R-square value while simultaneously reducing the significance of crude oil prices in the equation.

Separate weekly regression exercises involving the dollar index also failed to establish a meaningful correlation. Since the selected variables explain only about a quarter of the rupee’s movement, the analysis suggests that several non-quantifiable factors — including the evolving geopolitical situation, the progress of the conflict in West Asia, and policy signals or statements emerging from the United States — continue to play an important role in shaping the rupee’s trajectory.

Conclusion
The recent movement in the rupee suggests that the currency is being tested in successive one-rupee bands, with the market gradually moving from Rs 94 to Rs 95, then to Rs 96 and now towards the Rs 97 per US dollar level. Once a higher range has been reached, the rupee has shown little tendency to reverse course meaningfully, indicating persistent underlying pressure on the domestic currency. This gradual but sustained depreciation trend reflects continued market concerns over external vulnerabilities, capital outflows, and elevated geopolitical risks.

India’s foreign currency assets, excluding gold, stood at US$ 573.1 billion as of February 27, before declining to US$ 552.8 billion by May 8. A significant portion of this decline — nearly US$ 10 billion — occurred during the first week of the conflict, in the week ending March 6, highlighting the immediate impact of geopolitical tensions on India’s external reserves. The initial shock was partly cushioned by intervention from the Reserve Bank of India (RBI), which reportedly sold dollars in the market, alongside valuation gains in non-dollar foreign exchange assets.

Meanwhile, global crude oil prices have continued to hover near the US$ 110 per barrel mark, keeping pressure on India’s import bill and currency outlook. In the absence of any meaningful positive development on the geopolitical front, markets are expected to continue testing the Rs 97 per US dollar level. Based on the observed pattern of the rupee remaining within specific trading bands for nearly five sessions before shifting higher, analysts believe it may not take long for the currency to breach the Rs 97 mark, especially with the Rs 96–97 range already prevailing for three consecutive trading sessions.


DILIP KUMAR JHA
Editor
dilip.jha@polymerupdate.com