The warning lands as the rupee closed at 90.07 per U.S. dollar, slipping 0.1% on the day and cementing a roughly 5% drop this year, the steepest decline among major Asian currencies.
5 channels of impact
BofA said the rupee’s weakness, nearly 7% over the past year and even larger in real effective terms, is among the most pronounced in recent history, and its effects will filter through the economy via five transmission channels:
1. Sentiment: Sharp FX moves historically dent manufacturing and services confidence and raise policy-uncertainty perceptions, often spilling into asset prices.
2. Growth: Imports respond first to depreciation, contracting as costs rise. Exports improve later and more modestly, with BofA noting that exchange-rate sensitivity has weakened in recent years.
3. Inflation: Depreciation typically raises inflation via imported inputs, precious metals and intermediate goods, though BofA expects the impact to be blunted by low crude and commodity prices.
4. External balances: Trade and services balances generally improve with a lag after depreciation, even if uncertainties around the U.S.–India trade deal limit near-term export gains.5. Fiscal finances: Higher subsidy outlays, especially for LPG and fertilisers, can strain the budget, while RBI’s larger FX earnings from intervention could boost dividends, leaving the net fiscal outcome “unclear.”
Rupee weakness among steepest since past crisis episodes
BofA compared the currency’s slide with earlier downturns in 2008, 2013 and 2018, noting that the rupee has weakened 8.6% in REER terms year-to-date and over 12% over the past year, a magnitude rarely seen outside major stress periods.
The drag comes against a backdrop of divergent asset performance: the Nifty 50 has risen more than 9% this year, even as India trails the 25% rally in MSCI’s Asia ex-Japan index.
BofA said the latest depreciation phase “may persist in the near term,” citing uncertainty over the US-India trade deal and pressure on capital flows.
Capital flows under strain
The current account deficit remains contained, helped by crude at USD60–65/bbl and resilient services exports and remittances. But capital flows are “the primary challenge.”
FDI, FPI and debt inflows have slowed materially. Between October 2024 and September 2025, the RBI sold USD65 billion in the spot market and is running a USD63.6 billion short forward position, which likely expanded further in November as pressure intensified.
According to BofA, “continued portfolio outflows could make these operations unsustainable or build-up of RBI’s short USD forward positions may skew return expectations on INR.”
Strategists still see moderate appreciation next year
Despite the strain, BofA’s FX strategists expect USD weakness in 2026 to support gradual INR gains, forecasting the rupee at 86 per dollar by end-2026 if the trade deal is finalised and equity-market sentiment stabilises.
A pickup in India’s growth momentum, they said, would support corporate earnings and ease valuation pressures that contributed to this year’s equity outflows.
BofA expects the RBI to remain active in both spot and forward markets, noting the governor has reiterated that the central bank’s tolerance for FX volatility “has not changed.” The RBI is likely to smooth the pace of depreciation rather than defend any specific level, while opportunistically rebuilding reserves if inflows return.
While the typical pass-through is ~35 basis points of inflation for every 5% REER weakness, BofA said the impact in 2026 will likely be softer:
Crude oil in INR terms is cheaper than at the start of 2025.
India’s elevated retail fuel prices mean oil companies retain fat marketing margins, reducing the need for retail hikes.
China’s entrenched disinflation continues to suppress input-cost pressures.
Inflation pressures may still emerge in precious metals and some intermediate goods.
External balances may improve over coming quarters
Depreciation tends to strengthen India’s services balance, which improves 0.8% for every 1% FX weakness, according to RBI research cited by BofA, and typically boosts remittances once the rupee stabilises.
The trade balance improvement may be slower this time because of tariff-related uncertainty, but BofA still expects overall current-account pressures to ease in the next 3–6 months.
A weaker rupee can push up fertiliser and LPG subsidy costs, but the RBI’s heavy FX intervention means its foreign-exchange earnings and revaluation balances may rise.
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That could translate into a larger RBI dividend in FY27, helping cushion fiscal pressures.
Despite a robust year for domestic shares, the rupee remains Asia’s worst performer, a position highlighting the depth of the five-channel shock BofA says is now in motion.
