The Currency Divergence Paradox: Why is US Dollar Depreciating against major currencies, but the Indian Rupee is depreciating against the Dollar

The global financial landscape in early 2026 has been defined by a striking macroeconomic anomaly that challenges traditional exchange rate theories. Historically, the Indian rupee (INR) and the US dollar (USD) have maintained a relationship often influenced by the broader US Dollar Index (DXY), where a weakening greenback typically provides a reprieve for emerging market currencies.

However, the current cycle has produced a stark divergence: while the US dollar is depreciating against a basket of G10 currencies, dropping nearly 10% in 2025 - the Indian rupee has simultaneously plunged to all-time record lows, breaching the 92 level against the USD in January 2026. This paradox is not merely a product of random market volatility but is the result of a complex interplay between shifting global liquidity hubs, aggressive trade protectionism, and a structural realignment of monetary priorities between the Federal Reserve and the Reserve Bank of India.

The Bear Market of the US Dollar: Mechanisms and Trajectories

The decline of the US dollar throughout 2025 and into early 2026 marks one of the most significant structural shifts in the currency’s performance in the last two decades. The DXY, which serves as a benchmark for the dollar against major trading partners like the Euro, Yen, and Pound, concluded 2025 with a decline of approximately 9.4%. This downward trend has been largely driven by the convergence of interest rates between the United States and the rest of the developed world. As the Federal Reserve moved away from its restrictive "higher-for-longer" stance toward a series of rate cuts aimed at securing a "soft landing," the yield advantage that had long sustained dollar dominance began to erode.

Historical analogues provide a framework for understanding this decline. Quantitative analysis suggests that 1995 remains the most relevant comparison for the current period, as it also featured a technology-driven economic transition and a Federal Reserve pivot in the second half of the year. In that era, the dollar’s weakness persisted for several years, a trend that institutional analysts expect to replicate in 2026 with a forecast of the DXY falling toward the 94 to 95 range.

Beyond monetary policy, the dollar is contending with a fundamental shift in capital flows. During the first half of 2025, the DXY experienced its worst performance for that period in over 50 years, falling 10.7%. This was catalyzed by rising fiscal concerns surrounding the "One Big Beautiful Bill" (OBBBA) and its $4.1 trillion price tag, which raised alarms among international investors regarding the long-term sustainability of the US deficit. Furthermore, global asset managers have begun a significant reallocation of capital, moving away from US equities toward European and other developed market assets. This is evidenced by the decline in net flows into US-focused ETFs, which dropped from $10.2 billion in 2024 to $5.7 billion in the same period of 2025, while European-focused ETFs saw record inflows.

The Indian Rupee’s Underperformance: The Domestic Reality

Despite the broader global trend of a weakening dollar, the Indian rupee has failed to capture the benefits usually associated with a declining DXY. On January 29, 2026, the INR touched a lifetime low of 91.9850, nearing the psychologically critical 92 mark. This underperformance is particularly noteworthy because it occurs against a backdrop of "stellar" economic fundamentals, including a projected GDP growth of 7.4% for FY26—positioning India as the fastest-growing major economy for the fourth consecutive year.

The Economic Survey 2025-26 describes the rupee as "punching below its weight," a phrase that captures the disconnect between India's domestic economic strength and its currency's market value. The primary pressure on the currency stems from the capital account rather than the current account. Persistent selling by Foreign Portfolio Investors (FPI) has been the dominant force; outflows exceeded $18 billion in 2025 and continued at a rate of approximately $3 billion to $4 billion in January 2026 alone.

Sectoral Impacts and Trade Realities

The rupee’s decline is exacerbated by a widening goods trade deficit. While India maintains a surplus in services and remittances, these are no longer sufficient to offset the costs of merchandise imports, which rose to $63.55 billion in December 2025. This imbalance is a structural challenge that exposes the rupee to capital flow disruptions. The Economic Survey highlights that currency stability has historically eluded countries that could not become significant exporters of manufactured goods, noting that while IT services are macro-stabilizing, they cannot substitute for a goods-based export ecosystem.

The external environment has become increasingly hostile for Indian exports due to the "Trump Tariff" shock. Following his return to office, US President Donald Trump imposed steep duties of up to 50% on Indian merchandise exports. These tariffs were partly a response to India’s continued purchase of Russian crude oil and the perceived lack of reciprocity in trade negotiations. The tariffs have forced a recalibration of Indian trade strategy, but in the short term, they have significantly dented investor sentiment and heightened the demand for dollars as a hedge against further depreciation.

Monetary Mechanics: Comparing the "Money Printing" Narratives

A central question in the current currency debate is whether India is "printing" more money than the United States, thereby diluting the value of the rupee. An examination of the balance sheets of the Federal Reserve and the Reserve Bank of India, alongside their respective money supply (M2/M3) growth rates, provides a nuanced answer that goes beyond simple currency issuance.

The Federal Reserve: From Runoff to Reserve Management

Since June 2022, the US Federal Reserve has been engaged in a concerted effort to reduce its balance sheet, a process known as Quantitative Tightening (QT). Total assets on the Fed’s balance sheet declined from approximately $7.5 trillion in March 2024 to $6.6 trillion by September 2025. This reduction was achieved through the runoff of Treasury securities and agency mortgage-backed securities.

However, by late 2025, the Fed began to transition its policy. In December 2025, the Federal Open Market Committee (FOMC) concluded its balance sheet reduction and shifted toward "reserve management purchases" to maintain "ample" reserves in the banking system. As of January 2026, the US M2 money supply growth stood at 4.6% YoY, a normalization from the record highs of 26.7% seen during the pandemic in 2021. This suggests that while the US is no longer aggressively shrinking its money supply, it is not currently engaged in large-scale "money printing" of the kind seen in 2020.

The Reserve Bank of India: Strategic Expansion and Liquidity Surplus

In contrast, the Reserve Bank of India has overseen a significant expansion of its balance sheet. In FY 2024-25, the RBI's balance sheet grew by 8.2%, reaching ₹76.25 lakh crore. This expansion was driven by a 52.09% increase in gold holdings and a 14.32% rise in domestic investments. By early 2026, the RBI’s total assets were approximately $926 billion, reflecting a much faster growth rate compared to the US Fed during the same interval.

India’s broad money (M3) growth reached 12.1% YoY in December 2025, while M2 growth was recorded at 12.4% in November 2025. The acceleration in money supply was a deliberate policy choice by the RBI to support credit growth and domestic demand. In December 2025, the RBI reduced the Cash Reserve Ratio (CRR) by 100 basis points to 3.0%, releasing nearly ₹2.5 lakh crore into the banking system.

The difference in money supply growth—4.6% in the US vs. 12.1% in India—does theoretically imply a relative depreciation of the rupee according to Purchasing Power Parity (PPP) models. The Quantity Theory of Money, represented by the equation:

$$MV = PY$$

where $M$ is money supply, $V$ is velocity, $P$ is price level, and $Y$ is real GDP, suggests that if $M$ grows significantly faster than $Y$ (real growth), $P$ (inflation) must rise. In India's case, while $M$ is growing at 12.1%, real GDP growth $Y$ is also high at 7.4%, which absorbs a significant portion of the liquidity. Furthermore, India’s CPI has remained remarkably low, printing 1.33% in December 2025. Therefore, the rupee's depreciation is not primarily a result of "inflationary money printing" but is instead driven by the capital account and the narrowing of interest rate differentials.

The AI Hub Reallocation and Capital Account Volatility

A critical factor that has bypassed traditional economic models in 2026 is the structural shift of global capital toward markets perceived as "AI-centric." Institutional analysis reveals that FPI flows in FY26 were redirected away from diversified emerging markets like India toward hubs of artificial intelligence infrastructure, such as the United States, Taiwan, and South Korea.

This trend has created a "growth paradox" for India. While the country's domestic growth is the highest among major economies, it is not "the right kind of growth" for the current global investor appetite, which is hyper-focused on semiconductor manufacturing and AI software ecosystems. This is reflected in the 40.3% underperformance of the MSCI India ETF (INDA) compared to the MSCI Emerging Markets ETF (EEM) in USD terms over the last 16 months. The exodus of foreign capital, totaling nearly $23 billion during 2025 and January 2026, has put immense pressure on the INR, regardless of the DXY’s performance.

The Domestic Counterweight: DII Resilience

While foreign investors have retreated, Indian equity markets have been sustained by Domestic Institutional Investors (DIIs). Mutual funds and insurance companies have counterbalanced the volatility of FPI outflows, preventing a total collapse of the domestic indices. However, the currency does not benefit from this domestic recycling of capital to the same extent as it would from fresh foreign dollar inflows. The reliance on domestic capital means the rupee remains vulnerable to any external demand for dollars, such as month-end importer demand or corporate hedging.

Geopolitical Headwinds: The India-Pakistan Conflict and its Aftermath

The geopolitical stability of the South Asian region was severely tested in 2025 by a significant military escalation between India and Pakistan, often cited as "Operation Sindoor". Although the active conflict was brief—lasting approximately 87 hours—it functioned as an acute economic shock that impaired production and derailed years of developmental progress.

The immediate economic impact was staggering. Estimates suggest that India incurred at least $88.7 billion in realized costs, encompassing military asset losses, infrastructure destruction, and disrupted trade. For the duration of the conflict, the cost of war was estimated between $180 million and $600 million per day. This sudden requirement for fiscal borrowing and the resulting uncertainty led to a 1% decline in the rupee’s value and prompted $1.7 billion in foreign capital to exit Indian bonds.

The conflict also reopened the "Kashmir issue" to international mediation, creating a diplomatic setback that has contributed to a "strategic power gap" noted in the 2025-26 Economic Survey. This gap—where India operates below its strategic potential—has caused global investors to pause, questioning the country's ability to maintain a stable policy environment amidst regional volatility.

Trade Strategy in a Protectionist World: Tariffs and the EU Deal

The return of a protectionist administration in the United States has forced India to aggressively recalibrate its trade posture. The "Trump Effect" in 2025 was characterized by the imposition of 25% reciprocal tariffs in April, followed by a 50% penal tariff on a wide range of goods by August. These tariffs specifically targeted labor-intensive sectors such as textiles, leather, and seafood, which are crucial for employment and foreign exchange earnings.

In response to these pressures, the Indian government utilized the Union Budget 2026 to provide "firepower" to its industries. This included reducing tariff rates on dutiable goods imported for personal use from 20% to 10% and increasing the limit for duty-free imports of inputs used in seafood processing from 1% to 3%. These measures are intended to blunt the blow of American tariffs and improve the competitiveness of Indian goods in other markets.

The "Shotgun Marriage" with the European Union

Perhaps the most significant strategic move by India in early 2026 was the finalization of the "mother of all deals"—a free trade agreement (FTA) with the European Union. Negotiations, which had been stalled since 2007, were revived and concluded as a direct response to the aggressive trade posture of the US. Analysts refer to this as a "shotgun marriage" where Donald Trump held the shotgun.

The EU-India FTA is expected to provide India with much-needed market access for textiles, gems, and pharmaceuticals, while the EU gains access to the Indian automobile and beverage sectors. While this deal is a long-term strategic hedge that will eventually stabilize the rupee by diversifying trade flows, the immediate market reaction has been tempered by the "sticky issues" remaining in US-India relations, particularly regarding India’s purchase of Russian oil.

The Russian Oil Dilemma and US Strategic Pressure

The primary "sticky issue" in US-India trade negotiations remains India’s continued reliance on discounted Russian crude oil. The Trump administration has consistently pressured New Delhi to scale back these purchases, alleging that they indirectly fund the Russian war effort in Ukraine. US Trade Representative Jamieson Greer has stated that India stands to gain significantly from tariff relief if it addresses these concerns.

By January 2026, Indian crude buying showed a clear shift toward "lower-risk and more reliable" supplies from the Middle East, though Russian flows remain present but more "compliance-driven". The tension between the economic benefits of discounted oil and the strategic necessity of a US trade deal has kept the rupee in a state of flux. Exporters, anticipating that the rupee may fall further if a deal is delayed, have held onto their dollar earnings, further choking the supply of dollars in the domestic market.

Institutional Resilience: RBI Profits vs. Global Losses

A remarkable development in 2026 is the superior financial performance of the Reserve Bank of India compared to its global peers. While major central banks like the Federal Reserve, the Bank of England, and the ECB faced multi-billion dollar deficits due to mark-to-market losses on their bond portfolios, the RBI reported a profit of $31 billion (₹2.69 lakh crore).

This profitability is attributed to the RBI's disciplined treasury management and strategic decision-making regarding interest rates and foreign exchange reserves. Unlike many Western peers that were caught with legacy portfolios of ultra-low interest rate bonds, the RBI maintained a balanced approach, managing duration risk effectively. The resulting surplus has been transferred to the Indian government as a dividend, providing a critical fiscal buffer that allows the government to increase capital expenditure by 9% in FY27 even as the currency remains under pressure.

Forex Reserves as a Liquidity Buffer

Despite the rupee's depreciation, India’s external position remains fundamentally strong. Foreign exchange reserves reached $701.4 billion as of January 16, 2026, providing more than 11 months of import cover. This substantial buffer allows the RBI to intervene in the foreign exchange market to curb "excessive volatility" without the need to defend a specific exchange rate level. This "managed float" approach ensures that while the rupee may find new equilibrium levels, the transition remains "orderly" and does not threaten financial stability.

Inflation Differentials and the Crude Oil Outlook for 2027

The trajectory of the rupee in the latter half of 2026 and into 2027 will largely be dictated by inflation dynamics and the global energy market. In early 2026, India recorded its lowest inflation rate in a decade, with average headline inflation at 1.7%. This disinflationary trend, supported by a healthy kharif harvest and cooling food prices, allows the RBI to maintain an "accommodative" stance to sustain growth.

A critical tailwind for the rupee is the projected decline in crude oil prices. SBI Research expects the Indian crude basket to soften toward $50 per barrel by June 2026. Since crude oil constitutes the largest component of India's import basket, a 14% correction in oil prices could result in a 3% appreciation of the rupee, potentially bringing it back toward the 87.5 level by early FY27.

Conclusion: Synthesizing the 2026 Paradox

The simultaneous depreciation of the US dollar against G10 currencies and the Indian rupee against the dollar is a product of a unique historical juncture where capital account flows have superseded traditional trade-based valuation metrics. The US dollar is weakening as its exceptionalist growth and interest rate narrative moderates. Simultaneously, the Indian rupee is being pressured by a "perfect storm" of persistent FPI outflows, the structural drain of liquidity toward AI hubs, the economic and psychological aftershocks of the 2025 regional conflict, and the unprecedented tariff barriers imposed by the US.

The evidence refutes the simplistic notion that India is merely "printing more money" than the US. While the RBI’s money supply growth (12.1%) is higher than the Fed’s (4.6%), this is consistent with an economy growing at 7.4% versus 1.8%. The rupee’s "undervalued" state is currently serving as a strategic cushion that blunts the impact of US tariffs on Indian exports.

Looking forward, the resilience of the Indian economy—backed by record central bank profits, robust domestic investment, and a successful strategic pivot toward the European market—suggests that the rupee is poised for a recovery as global interest rates converge and the US-India trade negotiations move toward closure. The current record low of 92 is likely a floor established by the capital account exodus, which is expected to reverse once the "AI hubs" reach valuation maturity and global investors return to the high-growth fundamentals of the Indian market.