The Reserve Bank of India (RBI) has sounded a note of caution, identifying a cluster of external risks that could potentially disrupt India's financial stability, even as it acknowledged the underlying resilience and strong growth momentum of the economy. The central bank issued this warning in its latest Financial Stability Report released on Wednesday.
Geopolitical Tensions and Trade Tariffs: The Core Risks
The RBI pinpointed external uncertainties as the primary threat. These include a further escalation in geopolitical conflicts, intensifying trade tensions, and a widening geoeconomic fragmentation globally. The report explicitly stated that such factors could lead to higher volatility in the exchange rate, weaker trade flows, lower corporate earnings, and muted foreign direct investments.
A direct consequence highlighted is the severe pressure on the Indian rupee. Data from Bloomberg crowns the rupee as the worst-performing currency in Asia in 2025. It began the year at 85.65 against the US dollar and has depreciated by over 6% since then.
The RBI attributed this depreciation to falling terms of trade, impacted significantly by tariffs, and a slowdown in capital flows. The central bank directly referenced the 50% tariff imposed by US President Donald Trump on Indian goods exported to the United States. With the effective US tariff rate on India being the highest among its trading partners, the rupee weakened even as the US dollar broadly softened against other major and Asian currencies.
"Importantly, the exchange rate has displayed a wider trading range, which in turn has imparted higher volatility. Currency derivatives markets also point to the likelihood of increased volatility going forward as trade tensions continue to weigh on market sentiments," the RBI noted.
FPI Exodus and Equity Market Concerns
The currency's pressure was worsened by persistent selling from foreign portfolio investors (FPIs). According to data from NSDL, overseas investors were net sellers to the tune of $18.9 billion in the Indian equity market in 2025. This marks a stark reversal from 2024, when they were net buyers of $124 million in equities.
The regulator also cautioned against a potential sudden and sharp correction in the US equity markets. Such an event, it warned, could trigger a correction in domestic stocks, erode investor confidence and wealth, accelerate FPI outflows, and tighten domestic financial conditions.
The report observed that Indian equity markets have shown modest performance compared to other emerging market peers this year. This comes after a five-year period of outperformance since 2020. Tepid corporate earnings growth amid relatively slow nominal GDP expansion, higher valuations, sustained FPI outflows, adverse tariff outcomes, and the rupee's depreciation have collectively weighed on market sentiment.
Adequate Buffers to Withstand Shocks
Despite these significant headwinds, the RBI's report conveyed confidence in the system's capacity to absorb shocks. It emphasized that the Indian economy and its financial system possess adequate buffers to withstand these risks.
These buffers include:
- Strong domestic growth drivers that provide fundamental support.
- Sizeable foreign exchange reserves held by the central bank.
- Sufficient capital and liquidity buffers within both the financial and corporate sectors.
In essence, while the RBI has clearly flagged the storm clouds on the horizon arising from global fragmentation and trade policies, it also underscores the robust foundations of the domestic economy that are expected to provide stability in turbulent times.
