The recent depreciation of the rupee to an all-time low of 84.92 against the dollar has reignited debates over the Reserve Bank of India’s foreign exchange strategy. While RBI’s interventions have aimed to ensure rupee stability, they come with significant economic trade-offs—tight liquidity, suppressed competitiveness, and resource-intensive interventions.
As India faces trade deficits, global uncertainties, and capital outflows, the central bank must pivot toward a more balanced and forward-looking rupee policy that can help it weather the storm while safeguarding India’s long-term economic growth.
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Why the rupee is under pressure
The rupee’s slide stems from multiple pressures. A record-high trade deficit of $37.84 billion, driven by weak exports and surging gold imports, has intensified external imbalances. Meanwhile, capital outflows have added to the pressure, with foreign institutional investors (FIIs) selling in the equity markets. Global headwinds, including a strong dollar, the Federal Reserve’s monetary stance, and geopolitical uncertainties, have further compounded the rupee’s woes.
While these factors are external, the RBI’s active interventions have led to domestic challenges. Frequent interventions have tightened liquidity conditions, driving up short-term interest rates at a time when growth momentum is already slowing. Though aimed at controlling volatility, these measures have inadvertently weighed on economic growth and weakened India’s export competitiveness.
Interventions and trade-offs
The RBI’s heavy interventions in both spot and forward currency markets to defend the rupee have come at a high price. Selling dollars in the spot market reduces rupee liquidity, which in turn pushes up interest rates when economic growth is already faltering. Furthermore, India’s forex reserves have fallen by nearly $50 billion this quarter due to intervention-related revaluation losses, leaving less room for sustained action. Resisting rupee depreciation has also eroded India’s export competitiveness, particularly at a time when global trade remains fragile.
A more flexible policy that allows the rupee to adjust somewhat to market forces can act as a natural stabiliser. This would help reduce gold and non-essential imports while boosting export competitiveness, which is critical for sustaining growth.
RBI needs to rethink strategy
The RBI must allow the rupee to weaken gradually in line with market fundamentals to restore competitiveness. A carefully managed depreciation can enhance India’s export advantage, particularly in labour-intensive and manufacturing sectors, while discouraging speculative gold imports, which surged fourfold in November. Such a pragmatic stance aligns with the macroeconomic principle of letting currency adjustments absorb external shocks instead of burdening domestic growth.
Rather than aggressively defending the rupee, the RBI should focus on smoothing volatility. Excessive interventions strain forex reserves without offering long-term benefits. A better approach would involve targeting speculative volatility while allowing market-driven adjustments to take place. This shift must be accompanied by clear and transparent communication to ensure markets remain confident and are not caught off-guard by unexpected interventions.
India’s forex reserves, currently at $658 billion, provide a cushion, but they must be used judiciously. Diversifying reserve assets to reduce exposure to dollar fluctuations and gradually building reserves during periods of rupee strength can better prepare India for future volatility.
Growth, inflation, and stability
The RBI faces the classic challenge of balancing inflation control, growth revival, and exchange rate stability. A pragmatic approach should prioritise gradual monetary easing to support growth as inflation moderates, aligning with global easing cycles. Simultaneously, the RBI must ensure that domestic liquidity remains adequate to prevent credit disruptions, especially during periods of intervention.
The central bank should also introduce targeted measures to curb non-essential imports and attract Foreign Direct Investment (FDI). By fostering an environment conducive to long-term capital inflows, the RBI can strengthen the rupee organically without resorting to frequent interventions.
From reactive to proactive policy
As the new RBI Governor Sanjay Malhotra settles down, the central bank must avoid repeating past mistakes of overburdening monetary policy with conflicting goals. Instead, the RBI should adopt a dynamic framework that moves toward a more market-determined exchange rate while smoothing excess volatility. Clear communication of intervention policies is essential to anchor market expectations and avoid unnecessary panic.
The RBI must also enhance India’s export competitiveness by supporting structural policies that reduce dependence on gold and energy imports. Such measures would not only stabilise the rupee but also help address India’s persistent trade deficits.
The global economy remains uncertain, with potential US policy shifts and changing trade dynamics likely to test India’s resilience. By allowing a calibrated depreciation and focusing on structural reforms, the RBI can bolster the economy’s competitiveness without compromising long-term stability.
The rupee’s depreciation is a wake-up call for policymakers. A rigid focus on currency stability risks economic growth and fiscal health. A well-calibrated approach that allows market-driven flexibility, protects reserves, and enhances export competitiveness is the need of the hour.
Under the new governor’s leadership, the RBI must pivot from reactive interventions to a forward-thinking, transparent rupee policy. Stability is essential, but it cannot come at the cost of growth. After all, a resilient economy requires a resilient rupee.