Answer

Introduction

Despite India’s strong macroeconomic fundamentals characterized by a projected 7% GDP growth and moderated headline inflation the Indian rupee has faced persistent downward pressure, breaching the psychological 92 per dollar mark in January 2026. This depreciation highlights a growing divergence between domestic stability and a volatile global financial environment, where external shocks often override internal strengths.

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Factors Responsible for the Recent Depreciation

• Aggressive US Trade Protectionism: The implementation of significant tariffs (up to 50%) on Indian steel and aluminum by the US administration has severely impacted export competitiveness.
  Eg: The resulting uncertainty in US-India trade ties has increased the currency risk premium on the rupee.
• Persistent Capital Outflows: Foreign Portfolio Investors (FPIs) have engaged in heavy selling, offloading equities worth over ₹16,000 crore in late 2025 due to high US Treasury yields.
  Eg: FPIs remained net sellers in early 2026, creating a “dollar-shortage” in the domestic equity market.
• Widening Trade Deficit: A record trade deficit (reaching $25.04 billion in Dec 2025) has increased the structural demand for dollars to settle import bills.
  Eg: High costs of crude oil (trading around $68/barrel) and electronic components continue to strain the Current Account.
• Safe-Haven Dollar Demand: Geopolitical tensions and the US Federal Reserve’s decision to hold interest rates steady have strengthened the US Dollar Index (DXY).
• Monetary Divergence: While the Fed maintains a hawkish stance, the market anticipates an RBI rate-cutting cycle (February/June 2026), narrowing the interest rate differential.

Scope of the RBI’s Intervention

• Volatility Management: The RBI operates a “managed float,” intervening primarily to curb excessive volatility rather than defending a specific exchange rate level.
  Eg: In January 2026, the RBI actively sold dollars via public sector banks to break the rupee’s “one-way momentum” toward 92.50.
• Dual-Market Operations: Using both spot and forward markets to manage liquidity without causing immediate spikes in domestic rupee availability.
• Strategic Tolerance: Under Governor Sanjay Malhotra, the RBI has shown a willingness to allow “calibrated depreciation” to protect export competitiveness against peers like China.
• Forex Reserve Buffers: Maintaining a robust reserve (over $650 billion) allows the RBI to act as a “lender of last resort” for dollars during extreme market stress.

Limitations of the RBI’s Intervention

• Impossible Trinity Paradox: The RBI cannot simultaneously maintain an independent monetary policy, a fixed exchange rate, and free capital movement.
• Imported Inflation Risks: Excessive intervention to prevent depreciation can lead to depletion of forex reserves, while ignoring it fuels “imported inflation” in fuel and edible oils.
  Eg: A 2% monthly depreciation in Jan 2026 has already raised costs for 85% of India’s crude requirements.
• Forward Book Liabilities: Heavy reliance on forward-market intervention creates future dollar delivery obligations, potentially complicating future reserve management.
• Limited Impact on Global Cues: The RBI has no control over US Fed policies or global oil prices, which remain the primary drivers of the rupee’s value.
  Eg: Despite RBI support, the rupee hit all-time lows in Jan 2026 following the Fed’s first policy meet of the year.

Conclusion

The long-term solution to rupee volatility lies beyond the RBI’s balance sheet. The strategy must transition from pure market intervention to economic diplomacy, such as concluding the India-EU FTA and diversifying trade payments into the Rupee. Strengthening domestic supply chains via the PLI scheme will reduce import reliance, eventually decoupling the rupee from the erratic swings of the US dollar.

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