The Indian Rupee has recently faced significant selling pressure, hitting a record low and becoming the worst-performing Asian currency this year by May 2026. This depreciation has been attributed to escalating geopolitical tensions, rising crude oil prices, and consistent selling by Foreign Institutional Investors (FIIs), all contributing to increased demand for the US dollar.
However, DSP Mutual Fund offers a contrasting perspective, suggesting that the worst of the pressure on the Rupee may be over. In a detailed report, the fund highlights that the Indian currency is currently at one of its most competitive levels in recent years, drawing support from valuation, inflation trends, and external account dynamics. The report argues that despite recent weakness, the Rupee’s trade-weighted position and domestic macroeconomic indicators provide a significant margin of safety.
Five Key Factors Supporting the Rupee's Outlook
1. Favorable Real Effective Exchange Rate (REER)
DSP Mutual Fund points to the Rupee’s real effective exchange rate, which stood at 89.7 at the end of April 2026, based on BIS data. It is estimated to have dipped even lower, below 88, when the USD/INR pair crossed 96.9 on May 20, 2026. This level makes the Rupee fundamentally undervalued on a trade-weighted basis, reaching its most competitive point outside of the 2013 "twin deficit" crisis and the 2008 global financial crisis.
2. Narrower Inflation Differentials with the US
India’s inflation differential with the United States is currently near its narrowest in recent history. Historically, this spread averaged 3.5-4 percent, but it has now compressed to 1-2 percent when comparing India’s core Consumer Price Index (CPI) with the US core Personal Consumption Expenditures (PCE). Over the past 12 months, US CPI averaged 2.8 percent while India’s CPI averaged 2.3 percent, a 50 basis point gap in India’s favor. This suggests a slower long-term depreciation trend for the Rupee.
3. Resilience in Balance of Payments
The fund asserts that current anxieties are driven more by expectations of crude oil consistently staying above $120 a barrel rather than actual realized stress. Services exports are robust, running above $418 billion annually, with the latest monthly rate nearing $447 billion annualized. A substantial services surplus of approximately $214 billion, combined with inward remittances exceeding $135 billion, creates a combined buffer of roughly $349 billion. This significantly offsets an FY26 merchandise trade deficit of about $333 billion. A sharper deterioration is only likely if oil prices remain above $120 for over 12 months; Brent currently hovers around $106 after briefly touching $120 in March 2026. Additionally, high gold prices have reduced jewellery volumes by nearly 25 percent, potentially limiting bullion-related pressure.
4. More Reasonable Large-Cap Equity Valuations
While headline valuations have caused concerns leading to muted FPI and FDI flows, DSP Mutual Fund notes that large-cap equities have quietly de-rated. Several prominent heavyweights are now trading below their long-term average multiples, and some segments are valued below 15 times forward earnings. In certain instances, these valuations are approaching levels seen during the Covid-era or the global financial crisis. This improved valuation landscape could establish a floor under FPI selling, especially as top-tier Indian companies continue to deliver strong return on equity, typically between 18-20 percent.
5. Cyclical Nature of Foreign Exchange Reserves and Flows
The report addresses the decline in the RBI’s headline foreign exchange reserves, which fell by $29 billion this year. The outstanding US dollar forward book stands at approximately 13 percent of reserves. DSP Mutual Fund clarifies that this situation is not unusual, noting comparable levels of 14 percent in March 2025 and 11 percent in March 2013. The RBI also held a net forward purchase position of 11 percent in March 2022. Furthermore, FPIs have sold a net $34 billion of Indian equities in FY25 and FY26, marking the first back-to-back years of net selling since records began in FY99. The fund emphasizes that these dynamics are part of a normal economic cycle.
In conclusion, DSP Mutual Fund suggests that when viewed in context, the Rupee’s depressed REER, tighter inflation differential, robust external buffers, improved large-cap valuations, and cyclical reserve dynamics collectively indicate that the current pressure on the currency should be interpreted with a nuanced understanding, hinting that a stabilization or recovery might be on the horizon.