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India needs a comprehensive and structural policy response to manage rising risks from rupee depreciation, imported inflation and a widening balance of payments (BoP) deficit, according to a report by the State Bank of India.
The report highlighted that the key concern at present is the "second-round effect" of external shocks, particularly through the exchange rate channel. It noted that depreciation in the rupee leads to higher imported inflation, while continued capital outflows further put pressure on the currency. It stated, "The current Rupee depreciation is not in line with India's macro fundamentals! It is therefore imperative to control the second-round effects... hence ensuring that inflationary expectations does not get de anchored..we need a structural solution to India's BOP deficit". Second-round effects refer to the indirect impact of an initial economic shock spreading through the wider economy. In this context, a depreciation of the rupee increases the cost of imports like oil and raw materials (first-round effect). Over time, businesses pass on these higher costs to consumers, leading to a broader rise in prices and inflation (second-round effect). This can also push up inflation expectations, making it harder for policymakers to control price stability. Data in the report showed that the rupee has depreciated 6.39 per cent between April 2025 and February 2026, with an additional 3.63 per cent depreciation observed post the West Asia conflict. At the same time, cumulative foreign institutional investor (FII) outflows of USD 6.4 billion have added to pressure on the currency. The report cautioned that exchange rate depreciation cannot act as a shock absorber indefinitely. Instead, it may turn into a channel for transmitting inflation into the domestic economy, especially through higher import costs. This could lead to inflation expectations becoming unanchored, thereby complicating monetary policy. On the external sector, the report projected that India's overall balance of payments could remain in deficit in FY27 at USD 28 billion, with the trade balance also expected to stay negative. The current account deficit is projected at USD 54.1 billion in FY27, compared with USD 31.5 billion in FY26. Although the capital account is expected to show a surplus of USD 26.5 billion, supported by positive capital flows, it may not be sufficient to fully offset the current account gap. The report also warned that the BoP could remain negative for the third consecutive year, underlining the need for urgent policy action. It stressed that relying solely on exchange rate movements is not a sustainable solution in a period of high global uncertainty and volatility. Instead, a broader set of measures is required to manage external imbalances and inflation risks. (ANI)
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