Global central banks are no longer marching in step. The United States Federal Reserve has recently cut its policy rate by 25 basis points, adjusting it to a range of 4-4.25 per cent.
In contrast, the European Central Bank (ECB) remains cautious, maintaining steady rates while balancing inflation concerns alongside sluggish economic growth. Japan continues its ultra-loose monetary policy stance, with near-zero rates and massive bond purchases. Concurrently, China is adopting an aggressive easing approach, cutting policy rates to support its slowing economy.
This divergence marks a departure from the post-pandemic trend, during which most central banks collectively tightened monetary policies to combat inflation. Now, the global monetary landscape looks fragmented: liquidity is being injected in certain regions while being withdrawn in others, resulting in yield differentials that scatter capital flows rather than channelling them uniformly.
Against this backdrop, the Indian rupee is experiencing downward pressure, having recently depreciated beyond Rs 88 to the dollar, marking a historic low. This decline is attributed to previous dollar appreciation and portfolio volatility. Conventional economic theory would suggest that a weakening rupee makes India less attractive to foreign investors. However, paradoxically, the money keeps coming in.
The paradox of inflows
Foreign portfolio inflows (FPIs) into India have surged, crossing $14.6 billion in equities while investing nearly $9-10 billion in debt in FY25.
The momentum is set to accelerate with India’s inclusion in JPMorgan’s widely tracked Emerging Market Bond Index, which began in June 2024 and is set to reach full weight by March 2025, expected to attract an estimated $20-25 billion in debt inflows during the inclusion period.
But the question arises, why would investors keep buying into India even as the currency weakens? Three reasons stand out:
Relative growth: India continues to be the fastest-growing major economy, with a projected growth rate of 6.5 per cent in FY2025. In comparison, the eurozone is expected to grow by 0.7 per cent, and the United States by 0.9 per cent, highlighting India’s significant growth advantage.
Macroeconomic credibility: In August 2025, inflation moderated to 4.9 per cent, aligning with the Reserve Bank of India’s tolerance band. The central bank has demonstrated a commitment to stability, neither panicking about the rupee nor letting inflation expectations drift. In an environment characterised by frequent policy changes, this steadiness stands out.
Index-driven and structural flows: Unlike volatile speculative capital, index inclusions result in more stable inflows. Pension funds and sovereign wealth funds are compelled to allocate resources to India simply because the benchmarks demand it.
Put together, these factors indicate that despite the depreciation of the rupee, India continues to be a magnet — safer than peers like Turkey, South Africa or Brazil, and offers greater returns than the US or Europe.
Also read: Why India should let the rupee fall
Divergent monetary policy and India’s sweet spot
Divergence serves as the hidden enabler here. When the Fed was implementing aggressive interest rate hikes through 2022-23, the resultant strength of the dollar effectively extracted liquidity out of the emerging markets. Today, with the Fed adopting a cautious approach to easing, the resultant suction effect is weaker. At the same time, Japan’s persistent accommodative monetary policy continues to export cheap yen liquidity, while China’s easing measures are pushing capital outward as investors seek to mitigate risks associated with a potential domestic economic slowdown.
This situation leaves investors scanning for economies that offer a combination of yield and credibility. Currently, India’s 10-year benchmark government bond yields approximately 6.5 per cent, although certain longer-term or less liquid bonds offer coupons nearing 7 per cent. With inflation under control and political stability, it is not as risk-free as US Treasuries, yet it offers significantly more security than the volatile emerging markets.
In short, divergent global policies scatter capital and India happens to be catching a disproportionate share of it.
Not all inflows are equal
The real question lies in what India does with this money. If a significant portion is directed toward stock markets and short-term debt instruments, India may face increased volatility, abrupt financial reversals, and upward pressure on the rupee that could adversely affect export competitiveness.
This phenomenon is not merely theoretical. In 2013, when the US signalled it would wind down its easy money policy — a moment called the “taper tantrum” — global investors pulled money out of emerging markets. This resulted in the Indian rupee depreciating by approximately 20 per cent within a few months as foreign investors withdrew their funds. More recently, in March 2020, a total of $16 billion was withdrawn within a single month as a result of the widespread panic induced by the Covid-19 pandemic.
The lesson is clear: short-term capital is inherently volatile. A weak rupee might coexist with capital inflows; however, unless these inflows are directed toward productive sectors, they won’t build economic resilience.
Also read: Nobody is speaking for middle-class taxpayers anymore. Rupee is falling, markets sinking
What India must do
So, how can India turn temporary monetary divergence into lasting capital depth?
Deepen domestic bond markets
The index-driven inflows present a rare opportunity for India to deepen corporate and municipal bond markets, thereby establishing long-term funding channels for infrastructure and green projects. Currently, corporate bonds are only about 17 per cent of India’s GDP, in contrast to 45-50 per cent in the US. Unlocking this market would convert transient flows into productive capital.
Channel money into green bonds and infrastructure
Global mandates for Environmental, Social, and Governance (ESG) and climate finance mandates are strong. If India undertakes the issuance of large-scale sovereign green bonds linked to solar, electric vehicle, and hydrogen projects, a portion of the capital inflows could be allocated to projects that also future–proof the economy. In the fiscal year 2023, India successfully raised about Rs 16,000 crore (around $2 billion) through its very first issuance of sovereign green bonds, followed by Rs 20,000 crore in fiscal year 2024, which represents only a fraction of what is possible.
Hedge volatility with policy clarity
The RBI should continue with its selective approach in foreign exchange markets, focusing on smoothing fluctuations rather than attempting to fix rates. Meanwhile, fiscal policy should refrain from alarming investors through abrupt changes in the taxation of capital gains or debt markets. Stability is a key component of the attraction; policy zigzags would undermine it.
Use rupee weakness strategically
A weaker rupee is not completely negative. It boosts exporters, particularly those in the sectors of engineering goods, textiles, and IT services. Notably, engineering alone constitutes approximately one-quarter of India’s merchandise exports, while textiles contribute to an additional 8 per cent. The task is to ensure that capital inflows do not lead to excessive rupee appreciation that erodes the edge.
India currently finds itself at a paradoxical juncture, characterised by divergent monetary policies abroad and paradoxical inflows at home, creating a fleeting sweet spot. Global liquidity cycles are subject to abrupt changes. If the Federal Reserve cuts more, the dollar could weaken, whereas a resurgence in inflation could prompt hikes to return. Either way, India cannot assume this moment will last. There is an imperative to use this window to deepen capital markets and enhance resilience, so that when the next shock knocks the door — be it a taper tantrum, a pandemic, or a geopolitical crisis — funding doesn’t evaporate overnight.
The narrative of a slipping rupee and diverging central banks can be interpreted in two ways: one of vulnerability, where India remains susceptible to the Fed or oil prices, and another of strength, where investors maintain confidence in India’s growth and macroeconomic credibility. Which story prevails depends entirely on what India does now. If policymakers channel temporary inflows toward sustainable capital, India has the potential to emerge from this divergence not merely as a beneficiary but as a financial anchor in an uncertain world.
Bidisha Bhattacharya is an Associate Fellow, Chintan Research Foundation. She tweets @Bidishabh. Views are personal.
(Edited by Aamaan Alam Khan)