May 29, 2026 | By the Elystar Team

The Indian rupee weakened by approximately 11% against the U.S. dollar during FY 2025–26, falling from ₹85.47 per USD on March 31, 2025, to ₹94.85 per USD on March 31, 2026. Conventional economic wisdom suggests that such a depreciation should make a country's exports more competitive, reduce imports, and ultimately stimulate economic growth. Yet, the immediate outcomes appeared to contradict these expectations. Exports showed limited momentum. Import bills remained elevated. Domestic demand for locally produced alternatives remained subdued. So, what went wrong? The answer is simple: nothing went wrong. In fact, the observed outcome is entirely consistent with established economic theory.

The Myth of Immediate Benefits

A common misconception is that a weaker currency delivers instant economic benefits. In reality, the effects of currency depreciation take time to materialize. International trade does not adjust overnight: Export and import contracts are often fixed months in advance. Businesses cannot immediately alter sourcing decisions. Consumers do not instantly switch from imported products to domestic alternatives. Foreign buyers require time to recognize and respond to changes in relative prices. As a result, the initial impact of currency depreciation can be surprisingly counterintuitive.

Understanding the J-Curve Effect

Economists describe this phenomenon through the J-Curve Effect. When a currency depreciates, the country's trade balance often deteriorates before improving. The trajectory resembles the letter "J". See Image 1.

• Short-Term Impact: The trade deficit widens because import prices rise immediately in domestic currency terms, while trade volumes remain largely unchanged.
• Adjustment Period: Businesses and consumers gradually respond to changing relative prices.
• Long-Term Recovery: Export volumes increase, import demand moderates, and the trade balance begins to improve.

Image 1. The J-curve effect in trade balance after currency depreciation.

Why Recovery Eventually Happens

Over time, market participants adjust their behavior. Foreign buyers begin to recognize that Indian goods have become relatively cheaper in global markets, making them more attractive compared to competing products from other countries. At the same time, higher import costs encourage domestic consumers and businesses to seek locally produced substitutes wherever feasible. These gradual adjustments help strengthen exports, reduce import dependence, and improve the trade balance over the longer term. However, this recovery is not guaranteed.

The Marshall-Lerner Condition: The Critical Test

Whether a depreciation ultimately improves a country's trade balance depends on a fundamental principle of international economics known as the Marshall-Lerner Condition. The condition states that currency depreciation will improve the trade balance only if: The sum of the price elasticities of demand for exports and imports is greater than one. In practical terms, this means that buyers—both domestic and international—must be sufficiently responsive to changes in prices. If demand for exports and imports remains relatively inelastic, even a substantial depreciation may fail to generate meaningful improvements in trade performance. The exchange rate may change, but behavior may not.

Looking Beyond the Headlines

Exchange rate movements often generate immediate headlines and market reactions. However, understanding their true economic impact requires a longer-term perspective. A weaker currency does not automatically translate into stronger exports or a healthier trade balance. The adjustment process is gradual, shaped by contractual commitments, consumer behavior, business decisions, and demand elasticity. The key question is not whether the rupee has depreciated. The more important question is: Will businesses and consumers respond strongly enough for the economy to move up the J-Curve and satisfy the Marshall-Lerner Condition? The answer to that question will determine whether today's currency depreciation becomes tomorrow's trade recovery.
 

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