Why a Stronger Rupee is Essential for Re-attracting FIIs to India

Right now, the exchange rate stands at about 87.8 rupees for one US dollar. This rate means that for every 87.8 rupees earned by an Indian company, the equivalent value in US dollars is only one dollar. This conversion rate is critical because foreign investors measure their returns in dollars. When the rupee is weak—at 87.8 per dollar—even strong performance in India might not translate into high returns when converted into dollars.

In the first week of 2025, foreign institutional investors (FIIs) have sold approximately 2 billion dollars worth of Indian stocks. On certain days, data from NSDL shows that FIIs recorded net selloffs of up to 416.5 million dollars in Indian shares, while they purchased only about 22.6 million dollars in Indian bonds. These figures indicate significant outflows, which signal that foreign investors are extremely cautious about keeping their money in Indian markets at the present time.

Additionally, the US dollar index—a measure of the dollar’s strength—currently hovers near 110. A strong dollar means that the US currency is robust compared to many other currencies, including the rupee. This high dollar index intensifies the risk for investors holding rupees because, when converting rupees into dollars, their returns are diminished. For example, if an investor earns profits in rupees and the rupee remains at 87.8 per dollar, those profits will lose value when brought back into US dollars. In a market where the US dollar is strong, the relative weakness of the rupee makes Indian investments less attractive.

The numbers are clear: a rupee exchange rate of around 87.8, combined with significant foreign selloffs of approximately 2 billion dollars and a dollar index near 110, creates an environment where FIIs are not inclined to invest further in Indian stocks. When foreign investors see these figures, they calculate that the conversion risk—the possibility of losing value when converting rupee earnings into dollars—is too high. They choose to pull their money out rather than risk lower returns.

Moreover, reports indicate that on some specific trading days, FIIs have experienced net outflows of 416.5 million dollars in equity and only modest net inflows of around 22.6 million dollars in bonds. These precise figures are hard to ignore. They show that foreign investors are actively managing their risk and are unwilling to remain exposed in a market where the rupee is under pressure. This behavior further contributes to the overall outflow of capital from Indian markets.

The Reserve Bank of India (RBI) has attempted to support the rupee by intervening in the foreign exchange market. On several occasions, state-run banks, acting on the RBI’s behalf, have executed orders that have temporarily improved the rupee’s performance. For instance, on one day, the rupee briefly traded at around 87.45 as a result of these interventions. However, these measures are temporary and do not change the underlying challenges. The persistent weakness of the rupee, despite RBI intervention, indicates that the fundamental issues remain unresolved.

Let’s look at the numbers again: with a rupee rate at approximately 87.8, large FIIs selling stocks amounting to nearly 2 billion dollars in just one week, and the dollar index maintaining a high level of about 110, the situation for Indian markets is difficult. When FIIs calculate their returns, they factor in these conversion risks. Even if a company in India achieves strong revenue and profit growth in rupees, the effective return in US dollars is eroded by the weak rupee. In simple terms, the value of their investment is significantly reduced when they convert rupee earnings back to dollars. This discrepancy is one of the primary reasons why foreign investors are hesitant to increase their exposure to Indian markets at this time.

The high US dollar index, which reflects robust performance by the US dollar, makes alternative investments in stable currencies far more appealing. Investors have access to markets where the currency is not under such strain, and the returns are more predictable when measured in US dollars. When the US dollar is strong and the rupee remains weak, it creates a scenario where the risk-reward balance is unfavorable for FIIs.

Furthermore, the situation is compounded by other economic factors. A weak rupee results in increased import costs for companies, particularly those that depend on foreign raw materials or technology. This increase in costs can squeeze profit margins significantly. Companies with foreign-denominated debt face higher repayment costs when the rupee depreciates, further stressing their financial performance. These factors are measured carefully by investors, and when they see that higher costs are likely to dampen profits, they decide to reduce their exposure.

To put it numerically, every time the rupee depreciates, the cost of repaying foreign debt increases, and this can have a multiplier effect on corporate earnings. Even a small increase in the rupee’s depreciation rate can lead to a significant impact on profitability when scaled up across an entire market. For instance, an incremental 5% depreciation in the rupee has been estimated to push up inflation by roughly 35 basis points over several months. This kind of pressure affects overall market sentiment, and investors become even more risk-averse.

In summary, here are the critical numbers and factors that drive the current situation:

• Exchange Rate:?The rupee is trading at about 87.8 per US dollar.
• FII Outflows:?In the first week of 2025, foreign investors have sold approximately 2 billion dollars’ worth of Indian stocks.
• Daily Data:?On some days, FIIs recorded net equity selloffs of around 416.5 million dollars and modest bond purchases of about 22.6 million dollars.
• US Dollar Strength:?The US dollar index is near 110, indicating a very strong dollar.
• RBI Intervention:?Temporary improvements have been seen, with the rupee sometimes reaching around 87.45, but these do not address the underlying issues.
• Conversion Risk:?Investors calculate that even if Indian companies perform well in rupees, the returns will be significantly lower when converted to US dollars due to the weak rupee.
• Investor Sentiment:?The combination of these numbers makes foreign investors cautious, and they prefer markets with more stable currencies.

The overall effect is that until the rupee shows a sustained improvement and becomes stronger against the US dollar, foreign investors are unlikely to re-enter the Indian market in a meaningful way. This lack of foreign investment slows down the overall recovery of Indian stock markets. The numbers tell a consistent story: a weak rupee, significant FII outflows, and a strong US dollar all combine to create an environment where the risks are too high for many investors.

Mathematical Model

Let’s start with the basic facts. Currently, the Indian rupee is trading at about 87.8 rupees for one US dollar. This number is very important because it tells us how much value Indian earnings have when they are converted into US dollars. For foreign investors, the return on their investments is measured in dollars, not rupees. So, even if an Indian company earns a good return in rupees, the final return in dollars depends on what happens with the exchange rate.

To explain this mathematically, consider the following formula:

Net Return (in USD) = [(1 + r_N/100) / (1 + r_d/100)] - 1

In this formula:

• r_N?is the return on the investment in Indian terms (for example, the percentage return of the Nifty index).
• r_d?is the percentage depreciation of the rupee against the US dollar over the same period.

This equation tells us how the local return and the change in the exchange rate combine to give the overall return that a foreign investor will see in US dollars.

Let’s look at some examples:

Example 1: Moderate Return, Low DepreciationAssume the Nifty index returns?12%?in a year.Suppose the rupee depreciates by?8%?against the US dollar in the same period.Plugging these into the formula, we get:

??Net Return = (1 + 0.12) / (1 + 0.08) – 1 ????????

= 1.12 / 1.08 – 1 ????????

= 1.03704 – 1 ????????

= 0.03704, or?3.70%

This means that despite a 12% return in rupees, after accounting for an 8% depreciation in the rupee, the net return in US dollars is only about 3.70%.

Example 2: Moderate Return, High Depreciation

Now, assume the Nifty index still returns?12%.But this time, the rupee depreciates by?15%.The calculation would be:

??Net Return = (1.12) / (1.15) – 1 ????????

= 0.97391 – 1 ????????

= –0.02609, or?–2.61%

Here, even though the local return is 12%, the rupee’s depreciation of 15% turns the net return negative by about 2.61%. In other words, the investor loses value when converting back to dollars.

These examples clearly demonstrate that if the rupee depreciates by a rate that is higher than the return on the domestic investment (for example, the Nifty index), then the net return for a foreign investor, when measured in US dollars, will be low or even negative.

This mathematical relationship is a key reason why FIIs are hesitant to re-enter the market until the rupee stabilizes. If the rupee remains weak, then even strong domestic returns will not translate into attractive returns in dollars. When foreign investors assess potential investments, they compare the returns they would get in Indian markets (after adjusting for currency changes) to the returns they could earn in other markets, especially in the US where the dollar is strong and yields are appealing.

For instance, if a foreign investor expects that the Nifty will return 12% in rupees but the rupee depreciates by 15%, the investor faces a net loss of around 2.61% when converting the returns into dollars. In such a case, the risk of currency depreciation outweighs the local market gains. This scenario makes Indian assets less attractive compared to investments in markets with more stable currencies, where the conversion risk is lower.

Moreover, the US dollar index being near 110 reinforces the attractiveness of US-based investments. With the dollar strong, the relative value of rupee-based returns decreases further, as investors know that a strong dollar means more buying power in their home currency. The strong dollar creates a situation where the expected return on investments in India, after adjusting for currency losses, does not compare favorably with returns available in markets with stable or appreciating currencies.

On top of this, the Reserve Bank of India has sometimes intervened to support the rupee. For example, state-run banks have stepped in on certain days, resulting in temporary improvements where the rupee might trade around 87.45. However, these interventions are short-term solutions that do not address the underlying issues. The key problem remains that unless the rupee stabilizes or strengthens on a more permanent basis, the net returns for foreign investors will continue to be diminished. This persistent currency risk means that FIIs will likely continue to hold off on re-investing in Indian markets until they see a clear and lasting improvement in the exchange rate.

When we look at these figures, it becomes clear that the strength of our currency is central to market confidence. The weak rupee not only diminishes the real returns on investment but also raises the costs for companies, which, in turn, affects overall market growth. The reluctance of foreign investors, reflected in the 2 billion dollars of selloffs in just one week, is a direct consequence of the high conversion risk and the high value of the US dollar.

There is a genuine need for a lasting improvement in the rupee’s value. This improvement could come from a combination of better economic policies, stronger domestic growth, and more effective measures by the RBI to address the underlying issues. Until that happens, the cycle of weak rupee, high outflows, and low foreign investment is likely to continue.

If the rupee remains at or around 87.8, and if we continue to see significant outflows—like the 2 billion dollars in one week—it is unlikely that foreign investors will gain confidence to return their money to Indian markets.

In conclusion, the recovery of Indian markets is deeply dependent on a sustained strengthening of the rupee. The current exchange rate of approximately 87.8 rupees per dollar, coupled with significant foreign outflows of up to 2 billion dollars in a single week and the strong US dollar index near 110, creates an environment where foreign investors are rightly cautious. Until the rupee improves and remains strong over a longer period, the risk for foreign investors will continue to be high, and they will likely continue to withdraw their investments. This, in turn, delays the overall market recovery.