Understanding an Undervalued Rupee: What Markets Might Be Missing

In one of our meetings, a client recently asked: "The rupee keeps falling. Should investors be worried? "

Every time the rupee weakens, headlines become more pessimistic, social media fills with predictions of economic trouble, and many investors assume a falling currency automatically signals a weakening nation. But currencies are often more complicated than they appear.

Markets frequently confuse movement with meaning.

The recent depreciation of the INR does not necessarily signal structural deterioration. In many ways, it may instead represent a cyclical adjustment that is temporarily uncomfortable but strategically necessary and that distinction matters.

Since May 2025, the rupee has faced meaningful pressure amid weak foreign capital flows, rising global risk aversion, and escalating geopolitical tensions in West Asia.

The pressure has largely originated from the external environment rather than from any significant deterioration in India's domestic economic foundations.

In a world where investors have gravitated toward a handful of themes such as artificial intelligence, U.S. exceptionalism, and commodity-linked opportunities, many emerging-market currencies have faced pressure. The rupee has not been immune. But  cyclical pressure and structural weakness are not the same thing.

India's Real Effective Exchange Rate (REER) which is one of the more important indicators currently being overlooked is Quietly Signalling , While most discussions focus on the USD/INR exchange rate, economists often pay greater attention to how a currency behaves relative to inflation, productivity, and its trading partners.

India's REER has fallen into the low-90s, a zone that has historically been rare and has often coincided with periods when the rupee appeared significantly undervalued in real terms. Since 2000, such levels have occurred only intermittently and have often been associated with periods of heightened pessimism around the currency.

History, of course, does not provide guarantees.

But it does offer perspective.

Historically, periods of significant undervaluation have often been followed by improving capital flows, stronger equity market performance, and eventual currency stabilisation.

That does not mean the future must unfold the same way; it simply suggests that we, as investors, should be careful about extrapolating today's fears indefinitely into the future.

In a recent interview, Montek Singh Ahluwalia spoke about India's long-standing obsession with currency strength. Many economists share a similar view. There is often an assumption that a strong currency reflects a strong nation. Historically, however, the relationship has worked in reverse. Strong economies build productivity, competitiveness, innovation, and institutional strength first. Strong currencies tend to follow.

At R&D Capital, we have observed that markets rarely move in straight lines toward equilibrium. They often overshoot in both directions. The same holds true for currency markets.

Yet markets do not remain disconnected from fundamentals forever.

Eventually, factors such as trade competitiveness, capital flows, remittances, interest-rate differentials, and relative valuations begin pulling currencies back toward equilibrium. This process can take time.

But history suggests that mean reversion remains one of the most powerful forces in financial markets.

At present, the rupee is experiencing temporary and cyclical weakness, but there is limited evidence to suggest that India's productive capacity is deteriorating structurally.

True currency crises are usually accompanied by deeper problems, such as:

* Institutional breakdown

* Unsustainable external debt

* Severe fiscal instability

* Collapsing productivity

India's current situation appears materially different. The present pressure seems more closely linked to temporary capital-flow reversals, geopolitical uncertainty, and shifting global asset-allocation cycles.

That distinction matters. We believe cyclical pressures can reverse far more quickly than structural deterioration.

Several developments could eventually support a more favourable environment for the rupee, including geopolitical stabilisation in West Asia, the normalisation of global capital flows, and continued improvements in India's manufacturing competitiveness and export capabilities. While the timing remains uncertain, these factors could help restore balance as current cyclical pressures begin to ease.

We as Investors May Need to remember that Currencies are among the most sentiment-driven assets. In global peaks of optimism, strength gets extrapolated indefinitely. At moments of stress, weakness gets mistaken for collapse.

But long-term wealth creation is rarely determined by short-term currency movements alone. The more relevant question is whether the underlying foundations of growth remain intact. If those foundations continue to strengthen, currency cycles eventually normalise around them.

A weaker rupee can create discomfort. It can dominate headlines. It can influence short-term sentiment. But currencies ultimately follow economic fundamentals more often than they dictate them.

For us, the lesson may be simple: currencies move in cycles, but economic progress compounds. Over time, the latter matters far more than the former.