The Rupee's Downward Spiral: How India-Pakistan Tensions Are Fueling Currency Pressure

The India-Pakistan conflict has escalated dramatically since April 2025, with military strikes, missile tests, and diplomatic spats dominating headlines. As geopolitical risks intensify, the Indian rupee (INR) has come under renewed pressure against the U.S. dollar, with the exchange rate hitting fresh lows. Investors should pay close attention: this isn’t just a political story—it’s an economic one with serious implications for portfolios.

The Conflict’s Escalation and Economic Fallout

The recent flare-up began with India’s Iron Resolve military exercises in April, followed by Pakistan’s test of the nuclear-capable Nasr-III missile. By mid-April, cross-border artillery exchanges had killed soldiers on both sides, prompting UN calls for calm. While a temporary de-escalation was agreed upon, tensions reignited in May after India launched retaliatory strikes against alleged militant camps in Pakistan. The resulting casualties and diplomatic posturing have kept markets on edge.

The human toll is tragic, but the economic impact is equally stark. shows the rupee weakening from ₹87.20/USD at the start of April to ₹88.50/USD by mid-May—a 1.5% decline. The Reserve Bank of India (RBI) has intervened aggressively, selling $3 billion in foreign reserves since April to stabilize the currency. Yet these measures have only slowed, not stopped, the rupee’s decline.

Why the Rupee Is Vulnerable

1. Geopolitical Risk Premium: Investors are pricing in the risk of further escalation. The RBI’s interventions can’t offset capital flight if fears of full-scale war grow.
2. Oil Imports and Trade Deficits: India’s current account deficit (CAD) widened to 2.3% of GDP in Q1 2025/26, driven by soaring crude oil prices ($95/barrel in April). With oil imports accounting for ~30% of total imports, every dollar rise in oil prices adds ~₹18,000 crore to India’s import bill. highlights the structural vulnerability.
3. Monetary Policy Constraints: While the Fed’s pause on rate hikes in May offered some relief, the RBI must balance defending the rupee with supporting an economy growing at just 6%—a slowdown from earlier estimates. Further rate hikes could hurt growth but may be necessary to stem capital outflows.

What’s Next for the Rupee?

The rupee’s trajectory hinges on two factors:
1. Conflict De-escalation: If diplomatic talks reduce military posturing, capital inflows could rebound. But with Pakistan vowing retaliation and India maintaining a hard line, that’s a big if.
2. External Shocks: Oil prices and global liquidity remain risks. A Fed rate hike or a spike in crude could push the rupee toward ₹89/USD—or worse.

The RBI’s $3 billion intervention since April has been a stopgap, but India’s foreign exchange reserves have dipped to $480 billion from $560 billion in early 2025. With $100 billion in external commercial borrowings maturing this fiscal year, the pressure to stabilize the rupee is existential.

The Investment Playbook

For investors:
- Hedge currency exposure: Consider shorting INR or investing in USD-denominated bonds.
- Avoid Indian equities: The Sensex has underperformed Asia’s MSCI index by 5% YTD, and geopolitical risks could widen that gap.
- Monitor oil prices: A $10/barrel rise could push the CAD to 3%, accelerating rupee weakness.

Conclusion: A Currency in Crisis Mode

The rupee’s decline isn’t just a side effect of geopolitics—it’s a symptom of deeper economic fragility. With CAD widening, oil prices elevated, and geopolitical risk premiums rising, the rupee could test ₹89/USD by Q3 2025. Even if the India-Pakistan conflict cools, the damage is done: the RBI’s credibility as a currency defender is on the line, and investor confidence in India’s macro stability has eroded. For now, the rupee’s downward spiral shows no signs of stopping.

Data Points to Remember:
- INR/USD closed at ₹85.84/USD on May 9, but that’s a misleading snapshot—April’s high was ₹88.10/USD.
- The RBI’s $3 billion intervention is small compared to the $12 billion lost to capital outflows in April alone.
- India’s CAD is now at a 7-year high, and the fiscal deficit is on track to breach 6.4% of GDP.

In this climate, the rupee’s fate is clear: it’s a currency under siege, and investors must treat it as such.