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ING’s Deepali Bhargava argues that India’s fuel subsidies and diversified energy sourcing have contained the inflation and growth impact of higher oil prices, but shifted pressure onto the Indian Rupee (INR). She sees weak capital inflows as the key drag, while improved Real Effective Exchange Rate (REER) metrics and Reserve Bank of India (RBI) reserves should help USD/INR stabilise later in 2026.

Rupee strain as flows stay weak

“India’s fuel subsidies are cushioning inflation for now, and diversified energy sourcing has eased supply pressures. But the strain has shifted to the rupee. Its recent slide reflects deeper structural weaknesses, especially chronically soft capital inflows. Unless those inflows recover, the rupee’s vulnerability is likely to persist”

“The biggest impact of higher global oil prices has been on the currency. This shift is less about an exceptionally large current account deficit and more about flows. While India’s external position is softening, it is far from crisis territory. We expect the current account deficit to widen to around 2.1% of GDP in 2026, up from around 0.5% in 2025, largely due to higher oil prices. Even with Brent averaging $104/bbl in 3Q, our CAD [Current Account Deficit] forecast of around 2% of GDP remains well below levels seen during past stress episodes such as the taper tantrum in 2013, where the current account deficit averaged over 4% of GDP. Yet, the extent of INR depreciation has been unusually large, reflecting weak capital inflows rather than current account imbalances.”

“Since then, however, the adjustment has been swift. The CPI inflation rate has nearly halved to an average 2.5%. The REER has declined by over 12%, bringing it back to levels last seen around 2014. On a broader valuation lens, the INR now sits near the bottom of its six-year REER range, indicating that much of the earlier overvaluation has been unwound.”

“Overall, while near-term pressures persist, the adjustment is already well underway. We expect USD/INR to end the year at 95.50, with risks skewed more towards gradual stabilisation than a disorderly weakening.”

The Indian rupee strengthened to around 95.4 per dollar, extending its rally for another session to a two-week high as sentiment improved on easing crude oil prices and supportive remarks from the Reserve Bank of India. Support for the rupee increased after Brent crude prices fell below $100 per barrel for the first time in over two weeks amid optimism that the US and Iran are moving closer to a peace agreement. Sentiment was further boosted after Sanjay Malhotra stated that the RBI would do “whatever is required” to ensure orderly forex market movements, adding that the rupee appears undervalued. He also said the central bank has around $700 billion in reserves to curb volatility. However, gains in the rupee were partly limited by persistent inflation concerns after India’s state-owned fuel retailers raised petrol and diesel prices for the fourth time in May to offset losses stemming from higher costs linked to the Iran conflict.