By CKG Nair & V Shunmugam, Respectively Former Director, National Institute of Securities Markets, and Partner, MCQube
Though the Union Budget 2026-27 heralded several positive measures to counter the global headwinds and was unveiled shortly after the landmark India-European Union (EU) free trade agreement (FTA), the market’s immediate response was negative. However, the surprise tariff reduction by the US made the market bullish and reversed the rupee’s recent downward trend against the US dollar.
While these external developments signalled a positive reassessment of near-term risks, they should be interpreted with caution. Such reactions often reflect shifts in sentiments rather than durable changes in balance-of-payments fundamentals. The central question therefore is not whether markets welcomed the Budget, but whether its provisions can sustain currency inflows once the initial repricing fades.
Much of the market optimism stems from developments outside the Budget. India’s progress in finalising an FTA with the EU has greatly enhanced medium-term export prospects and policy clarity. The US trade deal with India, promising lower tariff levels, accelerated market confidence. The timing of these events relative to the Budget amplified their impact as domestic fiscal signals benefitted from a positive external outlook. Nonetheless, attributing the strength of the currency and equities exclusive of the Budget measures may overstate their influence.
Markets seem to be assuming a calmer external environment, but the situation remains fragile. US trade policy, of late, is very unpredictable, often influenced by political motives rather than economic reasoning. Although the EU agreement offers some structural certainty, the US offer is conditional (the full picture is not yet clear) and could be reversed. In this context, external optimism may temporarily boost capital flows, but it can also quickly reverse, leading to increased volatility rather than stability in currency markets.
India’s Budget significantly contributes to currency stability mainly through its fiscal policy. Lowering the fiscal deficit to 4.3% of GDP for FY27 boosts macroeconomic credibility amid increasing global investor selectiveness. Alongside a `12.2 lakh crore capital expenditure plan, the fiscal strategy shows restraint while supporting growth—crucial for attracting foreign investment into debt markets where macro stability is highly observed.
However, fiscal discipline alone cannot guarantee currency stability. Portfolio debt flows are still impacted by global interest rates and changes in risk appetite. During global tightening or risk aversion, even fiscally disciplined countries face outflows. While the Budget enhances India’s standing, it does not eliminate the rupee’s vulnerability to external financial shocks.
The Budget’s capital market reforms are constructive but incremental, focusing on expanding corporate bond markets and enabling index-linked investments to diversify the investor base and promote more stable inflows. Over time, these changes could lessen reliance on volatile equity flows and improve the quality of capital entering the economy.
However, these measures are unlikely to significantly influence currency trends in the short term, especially since key reforms in capital gains taxation, particularly for long-term foreign investors, are missing. While the Budget avoids disruptive tax changes, it also misses an opportunity to make equity inflows more persistent, which are essential for currency stability.
The hike in securities transaction tax on derivatives aims to curb excessive speculation. Although it may lessen short-term volatility, its influence on currency flows is unclear. Speculative trading can intensify market swings but could also enhance liquidity. Without additional reforms in cash equities, the overall effect on market depth and foreign investor participation remains uncertain. From a currency perspective, priorities should include attracting long-term capital rather than simply reducing short-term trading. In this regard, the Budget’s measures are cautious rather than aggressive.
FDI remains the most dependable source of stable currency inflows, and the Budget continues to support earlier liberalisation efforts. Expanding production-linked incentives to advanced manufacturing sectors aligns with global supply chain diversification trends and leverages opportunities from the EU agreement. Additionally, streamlined approval processes and unified compliance portals help address long-standing execution challenges.
India’s FDI challenge is not a matter of policy intent but of the speed and process of approvals. Competing countries such as Vietnam and Indonesia provide quicker approvals, clearer tax benefits, and integrated infrastructure support. Without tangible progress in execution timelines, land availability, and contract enforcement, FDI inflows might stay below expectations and the level needed to stabilise the currency during global stress.
The Budget emphasises diversified inflows via non-resident Indian investments, International Financial Services Centre development, and potential retail bonds, adding resilience. Remittances, especially, act as a stabilising force because of their counter-cyclical nature. Policies that promote overseas employment and skill certification can support these flows. However, these channels are useful but cannot replace large-scale institutional capital flows. They serve as buffers, reducing volatility but do not fundamentally alter currency dynamics.
The recent rise of the rupee is driven by a combination of positive signals rather than a fundamental change. Better trade outlooks, fiscal discipline, and favourable global sentiment have temporarily come together. But periods of currency strength like this can hide underlying weaknesses. Should global conditions worsen or trade optimism decline, the pressure on the rupee could return swiftly, especially since India still depends on portfolio flows.
To convert episodic financial strength into sustained currency stability, India needs to extend reforms beyond the Budget. Implementing a simpler, more competitive capital gains tax system for long-term foreign investors would boost attractiveness. Also, speeding up dispute resolution and improving bankruptcy processes for cross-border investors would reduce risk premiums embedded in currency prices.
Broadening hedging options and improving access to long-term currency derivatives would help foreign investors manage risks more effectively, promoting longer investment horizons. Finally, targeted efforts to attract patient capital for infrastructure and manufacturing—possibly through partial currency risk-sharing mechanisms—could significantly improve the overall quality of inflows.
This Budget effectively enhances credibility and demonstrates restraint. Alongside positive trade developments, it has contributed to a short-term boost in currency and equity markets. But maintaining currency flows depends on more than credibility alone. Structural reforms, disciplined implementation, and resilience to global market fluctuations will determine whether the rupee’s recent gains are sustainable . The Budget provides a foundation, but more reforms are necessary to secularly sustain the strength of our currency.