Economic Survey: Undervalued rupee aids trade, but investor caution lingers

India's inflation rate will likely be higher in FY27 than in FY26

The rupee appears undervalued relative to India’s strong economic fundamentals, effectively punching below its weight.

 

While an undervalued currency offers some cushion against higher US tariffs on Indian exports and poses limited inflation risk amid benign crude prices, it can also temper investor sentiment, according to the Economic Survey 2025–26.

 

The resulting hesitation among investors to commit capital to India warrants closer scrutiny, the Survey added.

 

The rupee underperformed in 2025 among its peers.

 

Between April 1, 2025, and January 15, 2026, the rupee depreciated by around 5.4 per cent against the dollar, making it one of the most-depreciated currencies alongside the Japanese yen, which fell 5.5 per cent.

 

 

The Survey further said that while currency depreciation raises the risk of imported inflation, the impact is likely to be tempered by soft global commodity prices, led by lower crude oil prices.

 

The report said India’s inflation outlook for FY27 is expected to turn less benign, with both headline inflation and core inflation, excluding precious metals, likely to be higher than in FY26.

 

Inflation, if it edges up in the next financial year, it limits the scope for further monetary easing.

 

The Reserve Bank of India (RBI) has cut the policy repo rate by 125 basis points (bps) since February last year, due to benign inflation.

 

India has seen one of the sharpest declines in headline inflation among major emerging markets & developing economies (EMDEs), with inflation easing by about 1.8 percentage points. On the other hand, average core inflation was up from 3.5 per cent in FY25 to about 4.3 per cent in FY26. It rose from 3.19 per cent in April 2024 to 4.62 per cent in December 2025, creating the impression of sticky underlying inflation.

 

However, this persistence is largely driven by surging gold and silver prices.

 

When these components are excluded, core inflation exhibits a declining trajectory, broadly mirroring the moderation in headline inflation.

 

The widening balance-of-payments deficit, coupled with market uncertainty over the outcome of a trade deal with the US, exerted pressure on the rupee, leading to its depreciation.

 

Meanwhile, the rupee’s Asian peers saw relatively lower depreciation, including the Philippine peso, which fell by 3.8 per cent. And also, the Indonesian rupiah fell by 1.9 per cent during the same period.

 

On the other hand, currencies of economies such as Australia, Brazil, and South Africa appreciated during this period, supported by favourable terms-of-trade movements.

 

Between April 1, 2025, and January 22, 2026, the rupee depreciated by about 6.5 per cent against the US dollar, although the movement remained orderly.

 

The Survey said over the medium-to-long term, exchange rate dynamics are expected to be guided by structural fundamentals.

 

They include productivity gains, export diversification towards higher-value goods and services, deeper integration into global value chains, and a stable policy environment, rather than short-term fluctuations.

 

Further, the Survey highlighted that a weaker exchange rate is beneficial for India’s trade balance.

 

A 1 per cent appreciation of the rupee leads to a 1.26 per cent decline in net total trade.

 

The US dollar denominated value of the Indian rupee shows the strongest correlation with services exports among exchange rate measures.

 

This reflects the US’s role as a major destination for India’s services trade. Nearly 72 per cent of India’s software exports, accounting for about 46 per cent of total services exports, are invoiced in US dollars.