By — Aashrith Rajesh

Abstract

The Indian Rupee’s fall to record lows against the USD in 2025 has coincided with strong economic growth, giving rise to questions as to what is actually happening. This article argues that such coexistence is common in emerging markets where real outputs and incomes continue to rise despite nominal currency depreciation. By examining the “Dollar illusion”, distinguishing between nominal exchange rates and economic fundamentals, and assessing India’s external balances, the article shows that India’s economy stays resilient.

Introduction

The Indian Rupee has slid to a record low against the U.S. Dollar, breaking the 90 per Dollar mark. The irony is that the Indian economy has been growing throughout this time and is considered as one of the fastest growing economies. This coexistence of growth and currency depreciation is neither unusual nor paradoxical. It simply reflects a classic emerging market pattern where output incomes, and investment rise faster than the rate at which the currency is depreciating. This is driven by a strong domestic demand, which is supported by manageable external balances rather than solely by exchange rates. The Indian economy is worth somewhere around $4.3 trillion, representing around 3.9% of the world economy.

Despite this growth, the rupee has continued to depreciate throughout 2025. Exchange rate data indicates that the USD/INR averaged around ₹87, while weakening to above ₹90 by December. This depreciation has been attributed primarily to global Dollar strength, higher U.S. rates, and tariffs.

The Dollar Illusion

One of the most common pitfalls while analysing exchange rates is evaluating growth solely on dollar denomination. When the rupee weakens, converting the GDP to USD mechanically reduces its nominal Dollar value, even if the actual quantity of goods and services produced increases. This is what economists refer to as the money illusion, or in this case, Dollar Illusion.

Economists increasingly argue that a Purchasing Power Parity (PPP) adjusted measure offers  a more reliable gauge of an economy’s real size and living standards rather than the GDP, which estimates are converted at market exchange rates. Market conditions are shaped by forces such as capital flows, interest rates, monetary policies, and shifts in global risk sentiment, rather than relying on domestic productive capacity. Hence, currency movements can significantly alter an economy’s dollar-denominated GDP without reflecting any meaningful change in real output or welfare. This is noticeable in developing economies, where structurally undervalued and volatile currencies tend to understate real economic capacity and distort cross-country comparisons. From a policy perspective, relying on exchange rate-based metrics can therefore lead to misleading assessments of economic strength and living standards. Furthermore, reinforcing the case for PPP based comparisons in development analysis.

PPP-adjusted measure overcomes this limitation by taking into account the differences in domestic price levels and cost of living across countries. Instead of questioning how much an economy is worth at existing exchange rates, the PPP approach asks what amount of goods and services people can purchase within their economy. For example, the prices of non-tradeable goods and services such as housing and healthcare are significantly lower in developing countries, exchange rates tend to understate their real levels. PPP corrects this distortion by valuing output at comparable prices, thereby offering a more accurate basis for comparing living standards and real economic capacity.

Why growth and Depreciation can coexist

It is common to assume that if a country’s currency is weakening, its economy must also be weakening. However, economic growth and currency movements measure very different things. Economic growth refers to the increase in the production of goods and services within a country and is measured in real terms after adjusting for inflation. Currency depreciation however only shows how much the domestic currency is worth compared to another currency, such as the USD. As sources make it clear that India’s growth has been strong because of domestic demand, investment and output, while the rupee has depreciated against the USD.

A key economic distinction of nominal exchange rate and real purchasing power helps explain the coexistence. The nominal exchange rate tells us how many rupees are needed to buy $1 instead of being able to calculate how much people can buy with their incomes within India. What matters for living standards is whether real incomes and productivity are rising faster than prices. The World Bank emphasised that improvements in productivity and domestic activity can raise real income even if currency weakens.

Currency depreciation can coexist with growth because it supports certain parts of the economy. When the rupee weakens, Indian exports become cheaper for foreign buyers, which can increase the demand for services like IT, software, and business outsourcing. Deloitte India noted that rupee depreciation has helped maintain export competitiveness and supported services export while increasing costs of imports.

Is this a problem in disguise?

If currency depreciation was a signal for economic problems, it would create severe imbalances externally. However, India’s external position in 2025 has stayed moderately relative to GDP and has been cushioned by strong services export and remittances. India’s external balances allow the rupee to adjust gradually without triggering a balance of payments crisis.

India’s current account deficit narrowed to 0.6% of GDP in FY25, and is driven by a substantial service trade surplus of $188.8 billion, therefore strengthening the country’s external position. This resilience has given the RBI greater autonomy in setting monetary policies, which enable prioritising domestic economic conditions. The December cut on repo rate to 5.25% reflects a strategic choice to support growth rather than defend the rupee’s exchange level. In effect, the RBI has used exchange rate flexibility as a buffer against external shocks while supporting accommodative monetary conditions.

The rupee’s changing value has uneven effects throughout the economy. When the rupee weakens, exporters are usually the first beneficiaries. A weaker rupee means that Indian goods and services become cheaper for foreign buyers, making them more competitive in global markets. IT companies, software exports and pharmaceuticals are few of the many who benefit from this since they earn in dollars while meeting expenses in rupees. Additionally, households receiving remittances from abroad benefit from this. When dollars or other foreign currencies are converted into rupees, a weaker rupee means more money.

Data shows that India’s leading merchandise exports in November 2025 included engineering goods worth $11.01 billion, electronic goods worth $4.81 billion, and pharmaceuticals up 21%. These gains reflect how depreciation in currency makes Indian goods cheaper for foreign buyers.

However, there do exist some losers when the currency depreciates, mainly those who are dependent on imports. On the import side, petroleum fuel and oil account for around 31.4% of India’s total imports, precious metals at 11.9% and machinery at 8.8%. when the rupee weakens, these dollar priced imports become costlier, therefore raising domestic inflation on fuel, electronics,and other products. Another group which comes under pressure would be those companies with foreign currency debt. Firms that have borrowed in dollars must repay more rupees when the currency weakens, increasing their financial burden.

In the long run, rupee depreciation can support growth only if it is accompanied by structural gains in export competitiveness and a sustained reduction in import dependence. The government’s PLI framework is intended to expand domestic manufacturing capacity and reduce reliance on imported machinery and intermediate goods. Persistent depreciation, however, risks locking in higher imported inflation and eroding external balances rather than strengthening them. The RBI’s balance of accommodating monetary policy with exchange rate flexibility reflects a deliberate policy trade-off, supporting domestic growth while holding inflation risks and safeguarding external stability.

Conclusion

India’s experience in 2025 shows that a weakening currency and strong economic growth are not mutually exclusive. The rupee’s depreciation reflects global financial conditions and structural trade realities, rather than a collapse in domestic fundamentals. At the same time, real output, investment, and income have continued to expand, therefore driven by domestic demand and supported by manageable external balances.

Exchange rates capture relative prices, instead of welfare, productivity, and the direction of structural change within an economy. While currency depreciation creates clear distributional effects, it helps exporters while raising costs for importers. The more important question is not how strong the rupee is against the dollar, rather where real incomes and economic resilience are improving overtime. On that measure, India’s growth in 2025 stays intact.

About the Author

Aashrith Rajesh is a third-year law student from Jindal Global Law School (JGLS) particularly interested in Constitutional Law, Contracts Law and Intellectual Property Law. He enjoys reading on topics related to the world of finance and economics.

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