The rupee slid past the 91/mark in trade on December 16.

The Indian rupee touched a fresh record low, crossing the 91 mark against the U.S. dollar. Pressure on the rupee and tightening domestic liquidity is weighing not just on foreign, but also domestic investor sentiment.

What started as a currency and bond market issue is spilling over into stocks, prompting caution among both foreign investors worried about currency risks and local investors unsettled by liquidity stress.

According to Systematix Institutional Equities, the rupee's 6.6 percent slide this year is not cyclical, but has culminated from a decade-long managed depreciation that has eroded ~90 percent of its value since 2012. "Structural weaknesses, fading RBI firepower, and a protectionist global backdrop point to a new 6-7 percent annual depreciation norm, driving USD/INR toward 100 in 12–24 months."

As a result, analysts expect equities to face muted returns as a weaker rupee, sticky yields, and modest earnings growth favour selective sectoral exposure. The key sectors that will benefit from INR/USD depreciation will be information technology, pharma, automobiles, and metals. On the flip side, banks, public sector enterprises, oil & gas firms, energy and infra players will see pressure.

Rupee depreciation

The rupee has often been touted as Asia's most stable currency, with the title stemming from the Reserve Bank of India's intensive interventions. Since 2017, the rupee's average annual depreciation has been roughly four percent, although it could accelerate to 6 to 7 percent going ahead.

"Despite [RBI's] efforts to engineer stability, the rupee has still lost around 90 percent of its value since trading near 48/USD in 2012, lagging both broad USD and emerging-market currency benchmarks," added Systematix.

This year, the currency has seen continuous pressure since U.S. President Donald Trump's tariff announcements. The drop has continued to accelerate in the fourth quarter of the current calendar year despite RBI support, likely due to further widening of the current account deficit.

Emkay Global said the rupee is suffering on two fronts. First, exports have weakened in Q4CY25 due to front-ending earlier in the year before tariffs kicked in. "On the other hand, consumption recovery in the festival season would have pushed up import demand and put further stress on the external account. Further, elevated gold imports are accentuating the problem."

Rupee/CAD correlation

The long term correlation between the INR/USD pair and India's current account deficit (CAD) is positive, with the rupee tending to depreciate as the CAD widens, while its correlation with the capital account balance is negative, as rising inflows usually support rupee appreciation.

Capital flows are typically driven by India's fundamentals: economic strength, corporate earnings and relative valuations, alongside external factors such as the U.S. Fed's policy rate and the global trade environment.

As a share of GDP, total capital flows including net FDI, FPI, banking capital and external borrowings have fallen sharply from 8.8 percent in FY08 to 0.4 percent in FY25. The net FDI/GDP ratio has shrunk to 0.02 percent in FY25, the lowest reading ever.

This has coincided with a narrowing of the CAD excluding transfers, from 4.1 percent to 2.1 percent, after peaking at 6.7 percent in FY13. However, the brokerage noted that the decade-long shrinkage in CAD/GDP has not reflected genuine external strength "but rather a chronic domestic demand shortage, masked by inflated headline growth and the continued absence of private investment."

As global protectionism deepens, India risks further rupee weakness, slower growth, and a self-reinforcing adverse loop. "The durable escape lies in reviving domestic investment and productively harnessing its underutilized demographic potential, which demands moving beyond over-relied counter-cyclical monetary tools toward structural reforms," added the Systematix report.

Impact on equities

Continued stress on the external account will further impact sentiment. "We believe that the only durable solution to this negative cycle would be signing of the India-US trade deal, with substantial reduction in tariffs for Indian exports to the U.S.," said Emkay Global.

Until this happens, "financial markets in India remain vulnerable to periodic sell-downs, and equities will not be immune to contagion." Over the next few months, the brokerage believes that investors should increase their defensive exposure.

"Technology, Pharmaceuticals, and Private Banks remain the best ways to do this, given that their historic beta are the lowest. We would also trim exposure to smalland mid-caps, given the inherent high beta and expensive valuations," added Emkay.

The current volatility, and pressure on the market, is a "passing phase," and with the trade deal likely to conclude in three/six months, it should abate.

"The good news is that the domestic economy is gaining strength and the earnings cycle has turned in the last one or two months. From a long-term perspective, we remain constructive on Indian equities, with consumer discretionary our most preferred sector," it added.

However, Systematix cautioned that with slowing earnings growth, the currency PE ratio of 21-23X and peak market cap/GDP ratio at 128 percent, India is an "expensive market relative to most global markets, particularly China."

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