India’s fuel subsidies and diversified energy sourcing have contained the pass-through from higher oil prices to inflation and growth, but pressure has shifted to the Indian Rupee (INR) as capital inflows remain weak. India’s external balance is described as softening rather than distressed, yet the currency has depreciated more than current account dynamics alone would imply. ING expects the current account deficit to widen to around 2.1% of GDP in 2026 from around 0.5% in 2025, largely due to higher oil prices, even with Brent averaging $104/bbl in 3Q; that projection sits around 2% of GDP and remains below the over 4% of GDP average seen during the 2013 taper tantrum.
Adjustment in domestic conditions is characterised as rapid, with CPI inflation nearly halving to an average 2.5%. The real effective exchange rate has fallen by over 12%, returning to around 2014 levels and leaving the INR near the bottom of its six-year REER range. RBI reserves and improved REER metrics are presented as factors that could help USD/INR stabilise later in 2026, with USD/INR expected to end the year at 95.50.
Drivers of Rupee Weakness and External Risks
The strain on the rupee is coming from weak capital flows, not an underlying economic crisis. Foreign portfolio investors have been net sellers for three straight months, pulling over $4 billion out of Indian markets in May 2026 alone. This pressure has pushed the USD/INR to trade around 94.20.
While high oil prices, with Brent crude hovering near $102 per barrel, are widening the current account deficit, the situation is manageable. We project the deficit will reach 2.1% of GDP this year, a fraction of the 4%-plus levels seen during the 2013 taper tantrum. This suggests the rupee’s weakness is driven more by sentiment than by a severe imbalance.
Stabilisation Prospects And Trading Opportunities
We believe much of the negative adjustment has already happened, with the rupee now appearing undervalued on a real effective exchange rate basis. The Reserve Bank of India also holds a formidable buffer of around $635 billion in foreign exchange reserves. This gives the central bank substantial power to prevent a disorderly slide and ensure stability.
For derivative traders, this points to an opportunity to sell volatility in the coming weeks. With the outlook favouring gradual stabilization rather than a sharp crash, option premiums for far out-of-the-money strikes may be overpriced. Strategies like short strangles or selling call spreads could prove effective.
Considering the year-end USD/INR target of 95.50, selling call options with strikes at 96.00 or higher for later-dated expiries seems prudent. This approach bets against a chaotic weakening and instead positions for a slow, managed depreciation or range-bound movement. The key is to capitalize on the expected decline in implied volatility as fears of a currency crisis subside.
