Dollar Set to Weaken in 2026; Rupee Faces Unique Challenges – Insights by Abhishek Goenka
2025 marked the worst performance of the Rupee against the Asia Dollar index since 2013. The trade-weighted Real Effective Exchange Rate (REER) now hovers at 97.5, threatening levels not experienced since 2014. As we look ahead to 2026, it’s crucial to examine both the anticipated movement of the Dollar and the specific challenges the Rupee will face.
Expectations for Dollar Movement in 2026
Numerous complex geopolitical and macroeconomic factors are poised to influence the Dollar’s trajectory:
1. US Labor Market Trends: The labor market in the United States is showing signs of weakness, while inflation remains high. The market anticipates two rate cuts of 25 basis points each by the Federal Reserve by the end of 2026. Despite this, inflation is stubbornly persistent, failing to trend towards the Fed’s target levels. There is speculation that Trump will announce the next Fed chair by January, who may feel pressured to lower interest rates promptly. This scenario could indicate that the market is currently underestimating potential rate cuts.
2. Debt Management: The US Treasury must manage its debt rollover effectively, favoring low rates to keep interest expenses contained. Contributing to this Dollar-negative outlook is the divergence in monetary policy between the Federal Reserve and other significant central banks, such as the European Central Bank (ECB), which is likely to maintain a prolonged hold, and the Bank of Japan (BoJ), which appears hawkish.
3. Protectionism and De-Dollarization Trends: The rise in US protectionism, unwarranted interventions in global politics, and possible compromises on Fed independence could further accelerate the trend toward de-dollarization. Although this process may unfold gradually, it poses significant challenges for the Dollar.
4. Supreme Court Rulings: The potential ruling regarding the legality of Trump-era tariffs could also lead to a Dollar weakening. If deemed illegal, it might restore some confidence in the Dollar but could also slow the pace of long-term de-dollarization.
Challenges Faced by the Rupee
While the Dollar is set to weaken, the Rupee is not without its challenges:
1. US-India Trade Deal: The timeline surrounding the US-India trade deal remains critical. Prolonged negotiations could lead to increased market nervousness.
2. RBI’s Intervention Capability: The Reserve Bank of India’s ability to intervene will be under scrutiny, especially if pressures on the Rupee continue. The RBI faces the challenge of maintaining supportive rates and ensuring liquidity growth, while also considering the impact of Rupee depreciation on foreign investments.
3. Equity Market Performance: Indian equities underperformed in 2025, and January has seen Foreign Portfolio Investor (FPI) outflows. Factors contributing to this include trade and tariff uncertainties, lackluster domestic earnings growth, and high valuations.
4. Fiscal Consolidation: The government’s commitment to fiscal consolidation, despite its implications for growth, will limit the spending ability. This scenario necessitates a supportive monetary policy to encourage private investment, which in turn could pressure the Rupee.
5. Potential Bond Inclusion: There’s speculation regarding the inclusion of Indian bonds in the Bloomberg aggregate index, which could have a favorable impact on the Rupee.
Conclusion
In summary, 2026 is expected to be a pivotal year characterized by a weakening Dollar. While the Rupee faces a formidable set of idiosyncratic challenges, the extent of its underperformance is likely to be less severe than in 2025. Current corrections in overvaluation have placed the Rupee in a more undersold territory in REER terms. Investors should stay vigilant as both currencies navigate an evolving landscape.
(Disclaimer: The recommendations, insights, and opinions expressed in this analysis are those of the author and do not necessarily reflect the views of the Economic Times.)