How will US tariff hit rupee, foreign investment and the common Indian?

It isn’t only India’s exporters who will take a hit because of the 50 per cent trade tariff that the US has imposed on the country. It will also have ramifications in many other ways. A major concern, for example, is the depreciation of the Indian currency. If the rupee depreciates significantly, as early signs show, it will put inflationary pressure, slow foreign investments down and may even rapidly deplete the forex reserves.

Such a turn of events would impede growth, threaten jobs and wages, which would affect demand. A vicious circle indeed.

Rupee on downward slide

The rupee’s USD value took a big hit, peaking at Rs 87.9 on August 4, before falling to Rs 87.6 on August 8. In fact, it is one of the worst-hit Asian currencies, tumbling over two per cent in the past couple of months.

The actual devaluation may have been higher but for the Reserve Bank of India (RBI) which routinely intervenes in the forex market.

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India might see itself in a comfortable position at the moment with the forex reserve of $691.5 billion, as of May 30 – sufficient to fund more than 11 months of merchandise imports, said the central bank’s governor a few days ago. India’s current account deficit (CAD) also fell in Q3 of FY25 to 1.1 per cent of GDP.

If the rupee depreciates significantly, as early signs show, it will put inflationary pressure, slow foreign investments down and may even rapidly deplete the forex reserves.

But a prolonged intervention in the forex market would threaten this comfort. Unearned foreign remittances form a large part of India’s forex reserve.

Besides, when exports are hit, the USD inflow will dry up.

Relief for the rupee may come when the tariff is lifted (25 per cent is effective from August 7, the other 25 per cent will be from August 27), the US Fed cuts rate or the USD weakens. The Fed kept its rate unchanged earlier this month. The USD value against other currencies has been massively hit after Trump returned to power this January.

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According to Morgan Stanley, the USD dropped by about 11 per cent in the first half of 2025, its biggest decline in over 50 years, marking an end to its 15-year bull run.

Why rupee value may go down?

Abhijit Mukhopadhyay, a senior economist at the Chintan Research Foundation (CRF) in New Delhi, explains a two-step process of devaluation. The first is the supply-side shortage of USD as export earnings fall, raising its demand. “It is a simple demand-supply dynamics”, he said.

The next will be an adverse impact of tariffs on growth.

Global investment banks are predicting 60-80 basis point fall in GDP growth, if the high tariff continues for a year. According to Mukhopadhyay, a slower growth will pull down both long-term foreign direct investment (FDI) and short-term foreign portfolio investors (FPI) – putting downward pressure on the rupee.

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Weak foreign investments likely to worsen

Official data show that growth in gross FDI inflow turned negative in FY23 (-16 per cent) and FY24 (-0 per cent). It turned positive in FY25 (14 per cent), but here is a catch. RBI data shows that net FDI inflows fell by 97 per cent in FY25 to $353 million – from $10.1 billion in FY24. This is because the existing FDI investors are pulling out or booking profits and repatriating home.

The FPI inflows dropped sharply in FY25 to $1.7 billion because, the RBI governor said, they too booked profits. In FY26 (up to August 7), the FPIs pulled out a net of $1.2 billion.

These are red flags – pointing to weakening of investments. A weak rupee and falling growth prospects will worsen sentiments.

The RBI is sure to intervene to keep the rupee value stable but that could be counterproductive.

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Wise for RBI to keep rupee value artificially high?

It is known that the RBI routinely intervenes in the forex market to keep the rupee’s USD value stable; buying USD to check appreciation in the rupee and selling USD to keep it from depreciating.

But why does it do it – instead of letting the market decide it – since it would threaten the forex reserves in the present situation?

Just how bad this market intervention was revealed by former chief economic advisor Arvind Subramanian, along with fellow economists Abhishek Anand and Jose Felman, in December 2024.

They wrote the RBI made a “radical change” in exchange rate policy sometime in 2022, which “led to a loss of about $200 billion over three episodes, with over $50 billion lost since end-September alone”.

In doing so, the RBI “abandoned the flexible exchange rate regime that had been in place for three decades and replaced it with a de facto peg against the dollar”.

They argued, this “reduced export competitiveness and rendered monetary policy inappropriate for a slowing economy” and warned that such an approach had historically proved counterproductive.

For one, when the RBI sells the USD to support the rupee, it dries up the domestic money supply (the USD is bought with the rupee) and the liquidity crunch threatens domestic growth.

The RBI never explained why it changed the policy.

Who benefits from RBI’s change in policy?

Subramanian and his colleagues ruled out the reasons for policy change as either fighting inflation or keeping the government happy with “a strong rupee”.

They analysed the conditions prevailing then to conclude that it could have been done to subsidise domestic companies which had substantial external commercial borrowings (ECBs). They presented data to show how ECBs skyrocketed in the beginning of 2023 and continued the upward march.

They provided the backdrop.

“At that point, the critical issue facing the authorities was how to translate India’s post-pandemic resurgence into a sustained boom”, they wrote.

Many private companies had ambitious plans, particularly in infrastructure, and needed finance, preferably ECBs which come with lower rates and longer maturity periods. But these plans were threatened when the US Fed started raising rates sharply, threatening the cost of repayment (increased interest) and the risks of rupee depreciation.

One “potential response” was to peg the exchange rate. They didn’t know if that was the main reason but asserted that reducing the effective foreign borrowing cost “was one of its main effects” and that this was so effective that ECBs took off despite rising dollar interest rate.

Eventually, they lamented, “the overall private investment did not take off” and “so, it is possible that the major effect of the “subsidy” – the reduction in exchange rate volatility – was that firms merely substituted foreign borrowing for domestic financing”.

It is time the RBI rethinks its novel “subsidy” scheme for big companies and doesn’t jeopardise forex reserves.

Who else is hit by rupee devaluation?

Broadly, for importers and ordinary Indians, a depreciating rupee will make widely used items such as smartphones and laptops costlier since India relies almost entirely on imports (components for smartphones).

The exporters will benefit from cheaper cost of their products but with all export orders on halt after the tariffs, that gain will have to wait. To what extent India's exports will be hit is not clear yet, some estimates suggesting 50 per cent of items such as electronics and pharma are in the US’s “exempted” list (merchandise exports to the US stood at $77.5 billion in FY24).