Will the Wild Ride for the Rupee Continue?

Consider this: the rupee fell by 57 paise to 86.62 on January 28, 2025-the steepest decline in nearly two years. From just February 10 to 13, the rupee quoted between 86.50 and 88.

In this period, some have questioned the Reserve Bank of India’s (RBI’s) handling of the situation, raising concerns about its decision to sell dollars to shore up the currency. The debate has also included top ministers in the Prime Minster Narendra Modi-led National Democratic Alliance government.

“Depreciation is a bad thing. We believe that in the long run, we must focus on a stronger currency because we are still an import-dependent country,” Union Commerce and Industry Minister Piyush Goyal said at the India Today-Business Today Budget Round Table 2025.

That said, Goyal added that the rupee has performed better than most emerging market peers. “The rupee is one of the best-performing currencies among emerging market economies. Our depreciation is roughly half in terms of percentage-we are about 2.8–3% compared to 5.5–6% that most other competing economies have seen,” he pointed out.

This tells us something about the attitude to the rupee’s depreciation-it is a touchy subject.

But Reserve Bank of India (RBI) Governor Sanjay Malhotra, who took charge at Mint Road last December, made clear it after the Monetary Policy Committee’s deliberation that “Our stated objective is to maintain orderliness and stability, without compromising market efficiency”. Accordingly, the central bank’s interventions in the forex market focus on smoothening excessive and disruptive volatility rather than targeting any specific exchange rate level or band. “The exchange rate of the rupee is determined by market forces,” he said.

RBI Under the scanner  

• However, the RBI’s stated policy, reiterated by new governor Sanjay Malhotra, is that it does not target a specific rate
• The RBI sold a speculated $70 billion in December 2024 to defend the rupee when it came under intense pressure
• The central bank has said it intervened to ensure that movement is orderly and there’s no excessive volatility
• Some observers have said that the RBI’s dollar sales led to a tightening in liquidity conditions in India
• But considering the uncertainty sparked by us president Donald Trump’s policy, the rupee is expected to feel pressure

Some Comfort

Besides, there are silver linings even with a weaker rupee: the current account deficit (CAD) moderated to $11.2 billion (1.2% of GDP) in the second quarter of FY25 from $11.3 billion (1.3% of GDP) in Q2FY24. The World Bank says India remains the largest recipient of remittances globally in FY24, with an estimated inflow of $129.1 billion. The CAD for this year is expected to remain well within the sustainable level. As at end-January 2025, foreign exchange reserves stood at $630.6 billion, an import cover of over 10 months or 99% of the external debt. And around two-thirds of foreign currency loans were hedged.

Yet, in December, when the rupee came under pressure, the spotlight was on the central bank’s foreign exchange sales to stem the slide. A view gained currency that the RBI should have let it slide and not have sold a speculated $70 billion. After all, the new US President’s world view was something that had to be dealt with. Then again, it has been the central bank’s long held view that it does not target a specific level for the rupee. So why defend the rupee by blowing precious forex?

Of course, there was a counter view that having linked the rupee’s value to national pride, could the RBI have let the rupee find its level? After all, the rupee has moved to its current level from around 63 to the dollar a decade ago. And if this, indeed, was to be the case, it would have meant higher imported inflation, which in turn, would have delayed repo rate cuts. The logic was simple: you can’t have a weaker rupee and lower interest rates.  

The Liquidity Crunch

The RBI’s dollar sales also brought another talking point into the picture: that it led to a tightening in rupee liquidity. This is not entirely true.

After remaining in surplus from July to November 2024, system liquidity-as measured by the average net position under the liquidity adjustment facility (LAF)-turned into deficit during December 2024 and January 2025. This is mainly attributed to advance tax payments in December 2024, capital outflows, forex operations, and a significant pickup in currency in circulation this January.

It is also misleading to pin the drainage of liquidity solely on the central bank’s dollar sales-every dollar sold sucks out an equivalent amount in rupees, and vice-versa. And the RBI Annual Report (FY25) details the developments that lead to the squeeze. Surplus liquidity moderated from August 12, 2023, following the imposition of the incremental-cash reserve ratio (I-CRR), a monetary policy tool to manage liquidity in the system, which resulted in around Rs 1.1 lakh crore moving out from the banking system. Then, the build-up of government cash balances due to advance tax collections and GST payments further tightened liquidity conditions. The average net liquidity adjustment facility slipped into deficit in September for the first time since May 2019.

Consequently, the average net LAF absorption moderated to Rs 89,000 crore in Q2FY24 from Rs 1.26 lakh crore in Q1. Liquidity turned into deficit with average net LAF injection of Rs 76,000 crore in Q3, driven by festival related currency outgo in October-November and build-up of government cash balances due to advance tax and GST payments in December 2023. Net LAF injection averaged Rs 1.36 lakh crore in Q4, with injections narrowing considerably in March 2024 from January-February.

Then the return-leg of the dollar-rupee sell-buy swap auction for $5 billion on March 8, 2022, also injected liquidity of Rs 42,800 crore on March 11, 2024. In Q4, the central bank injected liquidity through six main and 19 fine-tuning variable rate repo operations.

What now?

The bigger picture is as follows: the rupee will continue to gyrate. If the war between Russia and Ukraine ends, and sanctions are lifted on Russia, that may lead to the end of cheap oil supplies from that country months down the line. Will that show up in higher oil price-linked inflation and impact interest rates movements? That needs to be watched closely.

The RBI’s recent decision to cut the policy repo rate by 25 basis point to 6.25%—the first in five years—has not led to lending rate cuts by banks as their cost of funds will take time to go down. Higher provisioning for bad loans in some sectors, especially in unsecured retail credit means the headroom for lending rate cuts is narrower. Plus, the growth in deposits has just about managed to keep up with credit growth with the credit-deposit ratio of banks easing off 80 thereabouts. If, as a result of the repo rate cut, bank deposits were also to fall, then the CD ratio gets affected more. Besides, as stated earlier, the rate cut and the rupee’s depreciation cannot go together. When a currency is on the slide, it becomes costlier to buy the dollar. And the dollar does not get cheaper when interest rates are cut.

So, what is in store for the rupee?

The RBI may go easy on the rupee and give priority to domestic issues like other central banks. The fuss over the rupee’s level should end.