24/05/26, Rupee Depreciation

The critical stress area for the Indian economy in the previous financial year and into FY27 has been the value of the rupee. First it was the tariff hit on India that led to fears of a export slump and the rupee depreciated. There were hopes that the Indian currency would improve after the tariffs go. The Supreme Court of the US struck down the tariffs and yet there was not much improvement in the INR.

So what was happening? The stress for the economy is in fact not the current account but the capital account. Capital flows have significantly weakened and this is not a post war phenomenon. Even before the war, balance of payment (BoP) data reveals that the capital account was witnessing outflows, especially in Q3FY26, when the net outflows were at US$ 10 billion. The outflows on account of the FPI flows have worsened in Q4FY26, and this has continued even in Q1FY27. The fear is that the net outflows from the capital account can continue. The reason is partly global and partly local.

First, the globe is suffering from a fiscal crisis with sovereign debt levels elevated in USA and Europe. This was due to the government expenses in the Covid period when the focus for the Western world was to push cash in the hands of the people, to fight the crisis. For the USA, recent Pentagon briefings indicate that operational expenses are running at an estimated US$ 25 billion, with early estimates suggesting the initial weeks burned roughly US$ 890 million per day. This is a fiscal cost and further the Trump administration is forced to return the tariffs collected before the Supreme Court struck down the Trump tariffs as illegal.

This high fiscal burden anyways meant higher US Treasury yields. Now comes the war and the elevated oil prices is hurting US inflation on the energy costs and raising inflation risks in the economy. Markets are now pricing in for a Fed rate increase around October/December 2026, something that was not on the table before the war broke out and oil prices ramped up. Indeed, with US Treasury yielding high levels, would necessarily mean slowing down of flows to the EM economies, including India. Further, global flows have diverted to economies that have been at the forefront of AI investments.

Measures from the government have focused on driving austerity measures, thereby saving foreign exchange resources. On the RBI's front, the aim was to weed out speculative demand from the currency market, while capping the Net Open Positions of the banking sector to US$ 100 million. Recent measures have also targeted to reduce the imports of gold.

Gold imports in FY26 stood at US$ 72 billion and imports in April were reported at US$ 5.6 billion, still a strong 83.8 percent MoM growth and a share of 7.8 percent in total imports. In FY26 average gold imports stood at 8.9 percent of total imports, higher than 7.8 percent in FY25 and 6.6 percent in FY24. India remains one of the largest bullion markets and thereby weighs heavy on the import bill.

Given the continuing depreciation pressure on the currency, and with little wriggle room to increase capital flows, the government has decided to tighten the gold import volumes to gain ease the current account deficit (CAD). Thus, government has hiked import duty on gold and silver imports to 10 percent from 5 percent, and Agricultural and Infrastructure Development Cess (AIDC) to 5 percent from 1 percent earlier, taking the total effective import duty to 15 percent with effect from May 13.

Further, import quantity restriction of 100 kg has been imposed on manufacturers, including in SEZ under Advance Authorization scheme. Subsequent authorizations are only permitted if at least 50 percent of export obligations under previous licence has been utilized. These measures come on the top of dore importers awaiting licence renewals and the earlier waiver given to banks on IGST payments have not been reinstated. Our gold team thinks that with all these restrictions, the volume of gold imports can crash to around 420 tonnes in FY27, from 720 tonnes in FY26.

Some relief for CAD, but challenge on the capital flows may continue. Incorporating the volume view from our gold desk, we now anticipate gold imports to value at US$ 57 billion, compared to our earlier estimate of US$ 80 billion, a savings of around US$ 23 billion. The price hike on petrol and diesel, however, is not expected to lead to significant gains in terms of lowering crude import volumes.

Our calculations now indicate a CAD/GDP of 1.7 percent, from our earlier estimate of 2 percent, with assumption of oil at US$ 95 per barrel. The challenges on the capital account side are expected to continue, though the BoP deficit is now anticipated lower at USD 48 bn with the given assumption on oil.

Surely, the gold import restrictions would ease the pressure on INR but not completely take it away, unless the BoP gap is bridged. We do not think that the RBI would use interest rate as a tool to address currency depreciation pressures, while expensive ways out could be to garner resources through FCNR (B) route as was done in 2013.

But foreign exchange resources are still healthy at US$ 689 billion and policy makers can still wait for some time before taking any such drastic measures. Having said that, given the current thoughts on the Balance of Payments gap, we anticipate USD/INR at 97.00-97.50 by close of H1FY27.

Report by Indranil Pal of Network18