The Indian rupee experienced its steepest decline in two months, hitting an all-time low against the US dollar amid mounting global market pressures and the absence of central bank intervention. The currency's sharp fall reflects growing investor concerns over sustained foreign outflows and deteriorating market sentiment.

Record Low and Market Performance

The rupee's performance on Wednesday marked a significant deterioration in India's currency markets:

The currency emerged as the worst-performing Asian currency for the day, highlighting the severity of the selling pressure. This decline represents the rupee's biggest single-session fall in two months, underscoring the intensity of current market stress.

Contributing Factors to the Decline

Several key factors amplified the rupee's weakness. The Reserve Bank of India notably stayed away from the foreign exchange market, failing to provide dollar supply that could have cushioned the fall, according to traders. This absence of intervention allowed market forces to drive the currency to new lows.

Global market conditions further pressured the rupee, with a worldwide bond rout and US geopolitical tensions, including threats regarding Greenland, keeping investors on edge. These developments contributed to broader risk aversion in emerging markets.

Foreign Investment Outflows

Foreign investment patterns continue to weigh heavily on the rupee's performance:

Indian equities dropped 0.30% on Wednesday, following their biggest decline in over eight months on Tuesday. The persistent outflows reflect sustained foreign investor pessimism toward Indian assets.

Market Outlook and Analyst Views

Currency analysts point to structural challenges that may persist. Kunal Sodhani, head of treasury at Shinhan Bank India, noted that "flows mainly drive the USD/INR pair, thus weakness may continue to persist with interim legs of intervention expected from RBI in case of excess volatility."

India Forex Advisors highlighted that the currency will remain sensitive to corporate demand dynamics and portfolio flows. The firm warned that escalating global risk aversion would likely reinforce outflows, increasing downside pressure on the rupee.

Ongoing Challenges

Several factors continue to challenge the rupee's stability. While India's current-account deficit remains manageable, the lack of capital inflows presents a significant hurdle, leaving the currency exposed to further weakness. Importers show greater inclination to hedge compared to exporters amid expectations of further depreciation.

Additionally, the absence of progress on a US trade deal has deprived the rupee of a potential inflow catalyst. The weakness in most Asian peer currencies this year adds another layer of pressure that was largely absent in 2024, creating a more challenging regional environment for the Indian currency.

The Indian rupee faces potential further weakness, with projections suggesting it could slide to 92.5-93 per dollar if current market pressures persist, according to Dhiraj Nim, Economist and FX Strategist at ANZ Research. The currency has already reached fresh record lows, moving into what Nim describes as "uncharted territory" at a pace that has surprised many market observers.

Key Drivers Behind Rupee Weakness

Nim identifies two primary forces contributing to the rupee's decline. The first involves continued outflows from Indian markets, driven by visible stress from the ongoing earnings season and broader global risk concerns. However, he emphasizes that the more significant and persistent pressure comes from real money flows, particularly corporate hedging demand.

"I believe this weakness had been growing for quite some time, and it's not all of a sudden," Nim stated, suggesting a structural bias for further rupee weakening rather than temporary market volatility.

RBI's Measured Response Strategy

The Reserve Bank of India appears to be adopting a more tolerant approach toward the rupee's decline compared to previous interventions. Nim notes that since the pressure originates from fundamental flows rather than speculative activity, the central bank is less likely to intervene aggressively as it has in the past. This measured response provides the RBI with greater flexibility to address domestic liquidity concerns, which have become increasingly important according to ANZ's analysis.

Conditions for Rupee Stabilization

For the rupee to find stability and reverse its weakening trend, Nim outlines several critical requirements:

• Meaningful pickup in nominal gross domestic product growth
• Reduction in earnings-related market stress
• Improvement in current account deficit metrics
• Enhanced foreign direct investment inflows

Domestic Factors Driving Bond Yield Increases

Indian bond yields have experienced upward pressure, which Nim attributes primarily to domestic rather than global factors. The weak rupee has discouraged foreign bond inflows, while fiscal stress at both central and state government levels has added to yield pressures. Additionally, expectations of an inflation rebound contribute to the rising yield environment.

Nim contrasts this domestic-driven scenario with the spike in Japanese Government Bond yields, which he links to Japan's fiscal plans and broader global risk aversion. "I would believe that at least Indian yields currently are driven more by domestic factors," he emphasized.

The rupee's trajectory toward the 92.5-93 per dollar range represents a significant shift in India's currency landscape, with implications extending beyond immediate market movements to broader economic fundamentals and policy considerations.