Indian rupee traders are evaluating the currency's near-term prospects as the new year begins, following intensive Reserve Bank of India intervention in December that overwhelmed underlying market signals. The central bank's Financial Stability Report for December highlights a bearish outlook for the rupee amid rising volatility driven by US tariff impacts and declining foreign capital flows.

Recent Trading Dynamics and RBI Intervention

The rupee concluded trading at 89.87 on the last session, marking a decline of nearly 5% over the year. December proved particularly volatile, with the currency declining 0.46% while trading in an exceptionally wide range.

The Reserve Bank of India initially allowed the rupee to weaken before stepping in aggressively to support the currency. The central bank's heavy dollar sales flushed out long-dollar positions and reasserted control over price action, with the 90 level emerging as a potential soft line of defense.

Market Assessment and Trading Outlook

With major markets closed for New Year holidays, traders expect Thursday's session to feature thin volumes and limited price discovery, anticipating a largely flat opening and range-bound trade. The rupee has settled into a narrow band in recent sessions following the RBI's intervention.

"There will be conflicting forces at play in the near-term. I would say the underlying flows are still unsupportive (for rupee) and on the other side is RBI," a currency trader noted, highlighting the tension between market fundamentals and central bank support.

Foreign Investment and Economic Pressures

Foreign portfolio investment patterns revealed significant challenges for the rupee throughout the year:

The RBI report emphasized that India faces the highest effective US tariff rate of 50% compared to trading partners, contributing to the rupee's underperformance even as the US dollar weakened against other currencies.

Dollar Index and Global Factors

Beyond domestic flows, traders are focusing on the dollar index, which experienced a difficult year with a 9.40% decline. The performance of the US economy and Federal Reserve rate cuts are expected to be key drivers for the dollar, influencing the rupee's trajectory.

Currency derivatives markets indicate rising volatility expectations, with risk reversal indicators moving into positive territory, suggesting traders anticipate continued rupee weakness in the near term.

Economic Fundamentals

Despite currency market challenges, the RBI maintains that India's economy is positioned for strong growth, supported by robust domestic demand, benign inflation, and prudent macroeconomic policies. These factors provide underlying strength even as global uncertainties continue affecting currency markets.

The Indian rupee concluded 2025 with its largest annual decline in three years, falling 4.95% against the US dollar to close at 89.88 per dollar. The currency has become Asia's worst-performing currency this year, facing persistent pressure from foreign portfolio investor outflows and heightened dollar demand from importers.

Final Trading Session and Year-End Performance

On the last trading session of 2025, the rupee depreciated 13 paise to close at 89.88 against the US dollar as month-end demand and foreign portfolio investors' dollar buying kept it under pressure. At the interbank foreign exchange, the local unit opened at 89.89 and touched an intraday low of 89.95 and a high of 89.84.

"Since the Trump Administration took over, the rupee has been the worst performing currency in the Asian Region, depreciating by more than 5% during 2025, marking its highest depreciation in the last three years," said Anil Kumar Bhansali, Head of Treasury and Executive Director at Finrex Treasury Advisors LLP.

Foreign Investment Outflows Drive Weakness

The rupee's decline has been primarily driven by substantial foreign portfolio investor outflows, with $16.50 billion withdrawn from Indian equities throughout 2025. This represents a significant drain on investor sentiment and has contributed to the currency's persistent negative bias.

"Consistent outflows by FPIs and stake sales by investors, demand from defence, oil and gold have all impacted the rupee as it fell to its lowest at 91.08 before reined in to control it and bring it up to current levels," Bhansali noted.

RBI's Financial Stability Assessment

The Reserve Bank of India, in its Financial Stability Report released Wednesday, acknowledged the rupee's depreciation against the US dollar, attributing it to falling terms of trade due to tariff impacts and a slowdown in capital flows. Despite these challenges, the RBI maintained an optimistic outlook for the broader economy.

"The domestic financial system remains robust and resilient, bolstered by strong balance sheets, easy financial conditions, and low financial market volatility. Nonetheless, there are near-term risks from external uncertainties - geopolitical and trade-related," the report stated.

Market Dynamics and External Factors

Forex traders identified multiple pressure points affecting the USD/INR pair, including a shift toward risk aversion driven by persistent capital withdrawals from foreign investors ahead of the holiday break. The dollar index was trading 0.10% higher at 98.33, while Brent crude futures rose 0.13% to $61.41 per barrel.

The rupee's performance reflects broader challenges facing emerging market currencies amid global economic uncertainties and shifting capital flows, with India's currency bearing the brunt of regional weakness in 2025.