Examining India’s balance of payments data, Parikshit Ghosh notes that the rupee has been weakening in real terms not just in the recent months but over the last four to five years, reversing its earlier trend. The most likely cause is a decline in net foreign investments, which has happened over a similar time span. Oil prices and exports did not play a big role, but they can put additional pressure on the currency going forward.The falling rupee has been the topic of much discussion in the media lately. The dollar was around Rs 85 on 1 January 2025. It has now crossed Rs 95. The currency has lost 12% of its value against the dollar in less than a year and a half. Amidst all the flutter, two potential causes have received the most attention – rising oil prices and declining capital inflows. To conserve dollars, the Prime Minister has asked citizens to curb spending on gold, foreign travel, and imported goods. The government feels these are also significant pressure points for the currency. In this post, I seek to bring some quantitative perspective to the discussion.Figure 1a. India’s nominal versus bilateral real exchange rate against the US dollar (January, 2024-2026). Photo: Ideas for IndiaSource: Nominal Rs/US$ – Federal ReserveH.10, January monthly averages; India CPI – OECD (Organisation for Economic Co-operation and Development)/MoSPI (Ministry of Statistics and Programme Implementation, Government of India), 2015=100; US CPI – BLS, 1982-82 = 100, NSA.Figure 1b. Nominal versus real bilateral exchange rate: Rs. per US$, Q1 FY21 through Q4 FY26Source: BLS CPI-U: MoSPI All-India CPI (Combined, 2024 = 100); Federal Reserve H.10/G.5. Note: Real ER = Nominal x (US CPI/India CPI), CPI rebased to Q1 FY21 = 100.Since the purchasing power of all currencies erode over time due to inflation, a more economically meaningful measure than the nominal exchange rate (NER) is the real exchange rate (RER). It measures how many inflation-adjusted rupees are needed to buy one inflation-adjusted dollar1. Panel (a) of Figure 1 shows the annual NER and RER against the dollar from FY 2003-04 onwards. Panel (b) zooms in on the last five years and shows the trajectories for the quarterly averages. The RERs has been scaled to match the NERs at the beginning of a series.Historically, inflation rates have been higher in India relative to the US. This would be reflected in a rising nominal rate even if the rupee were to simply hold on to its relative purchasing power. Indeed, the graph shows that the NER, starting at around Rs 45 when the UPA (United Progressive Alliance) came to power, doubled by March this year. What may be surprising to some people is that in real terms, the rupee has strengthened over much of this period. The dollar is about 10% cheaper now compared to two decades ago. It strengthened significantly till 2011; it was relatively flat for a decade thereafter; but it has been weakening in the last five years, except for a two-year period when it hit a sort of plateau.Dollars flow into the Indian economy from exports, remittances by NRIs (non-resident Indians), and investments made by foreigners in India. Dollars flow out via imports and investments Indians make abroad. Import-exports and private remittances are grouped together in the current account, while investments are listed on the capital account. At the end of the day, inflows and outflows of dollars must equalise. In a largely flexible exchange rate system, it is the exchange rate that adjusts to clear the foreign exchange market.India has traditionally run a current account deficit, that is, we have imported more than we exported. However, this was balanced by a capital account surplus, that is, foreigners have typically invested more in India than Indians have invested abroad. The currency depreciates when some source of inflow suffers a negative shock or some source of outflow gets a bump. When that imbalance appears, balance can only be restored if either the rupee depreciates, or the RBI (Reserve Bank of India) sells dollars from its reserves to shore it up, or some combination thereof. Clearly, the current phase of depreciation was caused by persistent changes in some inflows or outflows.Drivers of depreciationFigure 2 shows that there is no significant trend in the overall volume of imports and exports during the period in question. Here imports are measured in inflation adjusted dollars, and exports are measured in inflation adjusted rupees, to filter out the effect of price rise and currency depreciation. Prima facie, it seems unlikely that this prolonged pressure on the currency arose from persistent shocks to goods and services trade. However, an important caveat must be mentioned. Had the currency not depreciated, the flow of imports and exports might have looked different, depending on the price sensitivities of importers and exporters.Figure 2. Real exports and real imports of goods and services, Q4 FY22-Q4 FY26 (Q1 FY21 base)Source: RBI, Balance of Payments – Quarterly (Rs crores); MoSPI (India CPI Combined); US Bureau of Labour Statistics (CPI-U).One specific import item, namely crude oil, has received much of the blame for the rupee’s most recent troubles. Nearly 90% of our crude oil use comes from imports, exposing us to substantial price risk. However, oil prices can hardly explain the rupee’s steady decline in real terms over the last five years. World crude prices were on a downward trajectory through much of this period, after the spike caused by Russia’s invasion of Ukraine in February 2022. They started climbing again only recently after the Hormuz crisis broke out in March of this year.Figure 3. India’s crude oil imports versus real net oil & gas import bill, Q1 FY21 through Q4 FY26Source: PPAC monthly snapshots (volume, nominal net bill); BLS CPI for deflation.Note: Real series in Q1 FY21 US$.Figure 3 shows India’s crude oil imports by quantity as well as value. Quantity is fairly stable at around 20 MMT (million metric tonnes) per quarter. There is not much room for substituting away from petroleum-based products in the short to medium term. Consequently, our energy import bill (which includes other products like LPG (liquefied petroleum gas) and naphtha) moves up and down pretty much in proportion to the movement in energy prices. Oil prices are certainly a worry going forward, but the steady depreciation of the rupee over the last several years has its roots elsewhere.The general buzz that there is some capital outflow from India, in the form of direct and portfolio investment, finds strong support in the data. This is not a recent phenomenon. It is noticeable for the entire five-year period over which the rupee has been weakening. The opposite is true for the previous five years. The three panels below illustrate these trends and their two-way relationship with the Indian stock market.Figure 4a. India’s real net FDI (foreign domestic investment), Q3 FY21-Q4 FY26Source: RBI Balance of Payments (quarterly); rebased to Q1 FY21 US$ using US CPI-U.Notes: (i) Quarterly, deflated to Q1 FY21 US$ (in bn.). (ii) Trend by OLS (ordinary least squares) on t = 0, 1,….,21.Figure 4b. India’s real net portfolio investment, Q3 FY21-Q4 FY26Source: RBI Balance of Payments (quarterly); rebased to Q1 FY21 US$ using US CPI-U.Notes: (i) Quarterly, deflated to Q1 FY21 US$ (in bn.). (ii) Trend by OLS (ordinary least squares) on t = 0, 1,….,21.Figure 4c. BSE (Bombay Stock Exchange) Sensex: Nominal versus real CAGR for Rs and US$ investors Source: FX rates from the US Federal Reserve (H.10 release); US CPI from US Bureau of Labor Statistics; India CPI from MoSPI.Note: CAGR is compound annual growth rate.Figure 4(a) shows quarterly aggregates of net FDI in real US dollars (base = Q1 FY 2020-21)2. There is an unmistakable downward trend with a slope coefficient that is statistically significant at 1% level. On average, net FDI (foreign direct investment) has been falling by about half a billion dollars per quarter and has even entered negative territory in some recent quarters. An examination of its components reveals all of them are moving in an adverse direction. New FDI is falling, repatriations are on the rise, and Indians are increasing their investments abroad.Figure 4(b) shows the picture for net portfolio investment into India, in real US dollars3. It represents new funds that have entered the Indian stock market from abroad. This series is much more volatile. Although there is a small downward trend, it is not statistically significant. However, from Q3 of FY 2024-25, foreign portfolio investment has been in negative territory as has been widely reported in the media.Figure 4(c) presents pre-tax nominal and real annual rates of return on the BSE (Bombay Stock Exchange) Sensex for domestic and foreign portfolio investors over two five-year periods: (i) one ending in March 2026, which is roughly the period of the rupee’s slide (ii) the previous five-year stretch4. The contrast could not be starker. The returns during the 2016-2021 period, used as a benchmark, are in line with historical numbers. In the last five years, Indian stocks have barely outperformed term deposits for domestic investors and have produced negative real returns for foreigners.Two major explanations for the decline in capital inflows have been going around. Some commentators, like Ruchir Sharma, are of the opinion that this is the result of a massive reallocation of global capital towards AI-related industries and countries that host them. Another view, pushed by economists like Surjit Bhalla and Arvind Subramanian, is that the outflow of foreign capital, along with the weakness of domestic private investment, is a canary in the coalmine that says something negative about our investment cliate.I will only point out that these explanations need not be mutually exclusive. Furthermore, international capital flows can be prone to self-fulfilling prophecies – weak returns and capital flight could become a feedback loop, and keep foreign investments depressed for a long time.Figure 5. Gold impacts: Quantity versus real value, Q4 FY22-Q4 FY26Source: Ministry of Commerce, Government of India / DGCIS (quantity and nominal value); US BLS CPI for real deflation.It is also interesting to look at another commodity import that has come into sharp focus – gold. Figure 5 depicts the trajectory of quarterly gold imports (in quantity and value). Unlike oil imports, import of gold shows no clear trend but very large fluctuations, ranging from as low as 125 tonnes per quarter to as high as 250 tonnes. The variation in value is even larger – from about US$5 billion up to US$20 billion, thanks to rising gold prices.Targeting gold imports to conserve foreign exchange, through import duties or moral suasion, seems like a promising strategy. However, it must be borne in mind that gold is demanded not only for consumption but also as an asset. Unnerved about equity markets and the safety of government securities, investors worldwide have sought refuge in gold in recent times. The large fluctuations in our own gold imports must largely be driven by investors, not consumers, whose demands are more stable. That is, the weakness of the currency and the stock market is itself generating a significant demand for gold. Which one policy should target is a bit of a chicken-and-egg problem.The policy outlookMany economists have been critical of the government’s long-standing interventionist stance towards energy and currency markets, arguing in favour of ‘letting the market find its price’. One must make a distinction here between price levels and fluctuations. Even if it is desirable to let fuel prices adjust to their long run market-determined trend, governments should try to reduce volatility around that trend, just as the FCI (Food Corporation of India) is mandated to seek food price stability. Most ordinary citizens do not have the knowledge or access to buy currency hedges and commodity futures to reduce their exposure to these risks. It falls upon the state to provide that insurance.Figures 6(a) and 6(b) illustrate that government policy has achieved a measure of stability for consumers using financial instruments (excise taxes and administered prices of fuel) but very little via physical instruments (strategic petroleum reserves). Since the end of Covid, the price of petrol at the pump (in nominal rupees) in Delhi has been almost flat and the excise tax has not moved around much either. This means the oil marketing companies (OMCs), instead of passing on fuel price changes to consumers, have generally absorbed them into their bottom lines. We will have to see if this implicit ‘social insurance’ holds up if the price of crude goes well beyond US$100 per barrel.Figure 6a. India oil sector – quarterly series, Q1 FY21-Q4 FY26Source: PPAC (crude basket, pump price); Ministry of Petroleum and Natural Gas (MoPNG) notifications (excise); RBI (Rs/US$ for Rs conversion.Figure 6b. Strategic petroleum reserve relative to monthly crude oil imports, 2025Source: Country crude oil import statistics and EIA (Energy Information Administration) strategic inventory estimates; India ratio uses ISPRL (Indian Strategic Petroleum Reserves Limited) government stocks.Note: China shows government-held only.The problem is that during times of cheap oil, the dividends the government earns as majority shareholder in the OMCs (oil marketing companies) disappears into the general budget as a line item and is spent without much forethought. When prices rise sharply, the government’s fiscal space becomes tighter, and even large subsidies to the OMCs could become necessary. It may be better to have a more explicit price stabilisation policy and either let the OMCs retain a greater part of their profits or park the dividend payouts in a well-managed national energy fund.Many countries, especially the OECD nations, have built substantial strategic petroleum reserves. They are invaluable during a crisis but can also be tapped to stabilise the oil import bill and prices at the pump. Figure 6(b) shows the size of the strategic reserves as a multiple of monthly import of crude for several countries. Clearly, India’s reserves are miniscule in comparison. While Japan’s reserves can service three and a half months of oil needs, and even South Africa can draw on theirs for a month and a half, India holds only five days’ worth of crude consumption in stock. Even with planned capacity expansion, we will have access to the equivalent of about two weeks of imports. Perhaps this instrument of energy security needs more attention.When it comes to currency management, the RBI’s avowed policy is indeed to reduce fluctuations without trying to influence the long run trend. The difficult part is to distinguish volatility from trend – that becomes clear only in retrospect, not in the moment. In the last two months, the central bank’s forex reserves have fallen by US$40 billion, which is more than 5% of its value. Defending the rupee at this rate is not sustainable for long. Sharp depreciation affects prices of critical commodities like fertilisers, cooking gas, and medical ingredients, and can be a painful hit on the pocketbooks of the poor. If the central bank cannot defend the rupee, the treasury must step in with other policies to shield the vulnerable.ConclusionIn this post, I reviewed some data relevant to India’s balance-of-payments problems. I have taken a longer view than the last few months and have compared inflation-adjusted values instead of nominal figures. The rupee has been weakening in real terms not just in the last few months but for the last four to five years, reversing its earlier trend. The most likely explanation for this is the decline in net foreign direct and portfolio investments. While rising oil prices or falling exports have not been a major factor so far, they remain significant risks given the state of geopolitics and the global economy.A falling rupee should not be cause for injured national pride. However, it imposes a significant burden on the poor. It may also be a symptom of underlying economic problems that need to be diagnosed and addressed.The author is grateful to Amartya Lahiri for helpful discussions.Notes: Formally, RER = NER × (US$ Price Index/₨. Price Index).Net FDI is defined as net FDI inflows (total direct investments made by foreigners in India minus repatriation) minus net FDI outflows (total direct investments made by Indians abroad minus repatriations back into India).Net portfolio investment is the difference between the value of shares foreigners bought and that of shares they sold.All rates are calculated on a CAGR basis. For rupee investors, the real rate of return is obtained by subtracting the compound annual inflation rate from the compound annual rate of return on the Sensex. For dollar investors, I convert dollars into rupees at the beginning of the period and reconvert it to dollars in the end, using spot market exchange rates. The nominal rate of return for a dollar investor is obtained by subtracting from this the compound annual inflation rate of the dollar over the relevant period.This article is republished from India for Ideas under a Creative Commons license. Read the original article.