Currency drivers: Rupee gains in March, outlook tied to US policy

The rupee gained against the dollar for nine straight trading sessions before giving up some gains on Tuesday. It has gained about 2 per cent in March and has been among the best-performing currencies in Asia. Nonetheless, it has lost about 3 per cent against the dollar this financial year, which will end next week. The currency has been somewhat volatile in recent months. In 2025, the rupee lost over 2 per cent until February but has nearly recovered the ground lost since. Currency-market volatility is driven largely by the movement in the United States dollar index, which itself has been volatile, partly because of the direction of US economic policy.

 

The US dollar index, which measures the strength of the dollar against a basket of currencies, went up over 5 per cent between mid-November 2024 and January 2025 in anticipation of the Donald Trump administration’s policies. The dollar index has since given up gains, which has helped other currencies. Foreign portfolio investors (FPIs) sold stocks and bonds worth over $8.7 billion in India in January. Selling pressure continued in February with FPIs selling Indian assets worth about $6 billion. Things changed in March with FPIs becoming net buyers in Indian equities, which has led to gains in the stock markets, though they remain net sellers in the debt market. The US policy outlook, particularly on the trade front, remains uncertain, with implications for global currency markets.

 

Mr Trump had announced that the US would introduce reciprocal tariffs on April 2. However, given the complexity of the idea, it is still not clear how those could be implemented. Recent statements suggest tariffs may be limited to select sectors and some countries may be exempted. US trade officials are in India and a lot from India’s point of view will depend on the outcome of the negotiations. India will likely have to reduce tariffs on a range of goods, which could lead to higher imports in the short run. However, it would also mean that India will be able to protect markets for its exports to the US. Depending on the outcomes of the trade talk, India could possibly benefit over the medium to long run by potentially gaining the space created by higher US tariffs on imports from China. A possible trade deal with the US could also help India negotiate trade deals with the UK and the European Union.

 

Beyond the immediate outcome of the trade deal, from the currency point of view, India is reasonably well placed. The projected current account deficit (CAD) for this financial year is at a modest 1 per cent of gross domestic product (GDP). Given the fact that global crude oil prices are in a comfort zone, the risk of the CAD expanding dramatically remains low. Thus, risks for currency could emanate mostly from capital flows. Projections by the US Federal Reserve, for instance, suggest it is on course to deliver two policy rate cuts this year. However, a change in expectations, in part because of tariff-related increases in inflation, could affect capital flows and increase pressure on the rupee. In the given circumstances, the Reserve Bank of India would do well to let the rupee depreciate because it will help the tradable sectors. The trade-weighted real effective exchange rate for February showed the rupee was overvalued by over 2 per cent, which is likely to go up in March with nominal appreciation. The medium-term outlook will become clear once the trade-related uncertainties are settled.