Why in News?

• The Indian rupee has witnessed a sharp depreciation, sliding close to ₹97 per US dollar amid rising oil prices, geopolitical tensions in West Asia, foreign capital outflows, and global financial uncertainty.
• The debate has intensified over whether the Reserve Bank of India should actively intervene or allow the rupee to “find its market level”.

What’s in Today’s Article?

• Why is the Rupee Falling?
• Debate on RBI Intervention
• Did Artificial Stabilisation Backfire?
• Exchange Rate Dynamics and Market Psychology
• Why Does Depreciation May Not Boost Exports Much?
• RBI’s Policy Approach
• Way Forward for India
• Conclusion

Why is the Rupee Falling?

• Pressure from the capital account:
  • Contrary to conventional explanations, the recent depreciation is not primarily due to weak macroeconomic fundamentals.
  • India continues to record relatively strong GDP growth, manageable inflation, and fiscal consolidation.
  • The core issue lies in the capital account:
    • Persistent Foreign Institutional Investor (FII) outflows since mid-2025.
    • Negative net Foreign Direct Investment (FDI) inflows during several months.
    • Rising US interest rates making dollar assets more attractive.
    • Heightened global risk aversion due to the West Asia crisis.
  • This has reduced dollar inflows into India while increasing demand for foreign currency.
• Role of balance of payments (BoP):
  • India traditionally runs a Current Account Deficit (CAD) because imports exceed exports.
  • This is usually financed through the FDI, portfolio investments, remittances, and external borrowing.
  • When capital inflows exceed the CAD, the BoP remains in surplus and supports the rupee.
  • However,
    • 2023-24 saw a large BoP surplus, allowing RBI to accumulate reserves.
    • 2024-25 moved back into deficit.
    • Capital outflows in 2025-26 intensified depreciation pressures.
  • Thus, the rupee weakened despite stable domestic fundamentals.

Debate on RBI Intervention:

• Argument for a market-determined rupee:
  • Economists argue that excessive intervention distorts markets.
  • A weaker rupee theoretically discourages imports, boosts exports, and restores external balance naturally.
  • They caution that defending a currency level can deplete forex reserves, delay necessary adjustments, and create future instability.
• Argument for RBI intervention:
  • Some economists argue that uncontrolled depreciation, especially when driven by speculative finance rather than fundamentals, can become dangerous.
  • Risks of unchecked depreciation:
    • Imported inflation, especially through crude oil.
    • Higher production costs due to import dependence.
    • Rising inflation expectations.
    • Panic-driven capital flight.
    • Adverse investor sentiment.
  • The RBI therefore intervenes not to target a fixed exchange rate, but to prevent “excessive and disruptive volatility.”

Did Artificial Stabilisation Backfire?

• A major policy debate concerns RBI actions during 2023-24, when the rupee was held largely within the ₹81-83 range.
• RBI sold or bought dollars aggressively to smooth movements. Critics argue this created an “artificial plateau”.
• As global pressures intensified later, the rupee saw a sharper fall because the depreciation that had been delayed earlier was eventually reflected quickly in the exchange rate.

Exchange Rate Dynamics and Market Psychology:

• Exchange rates are heavily influenced by sentiment.
• If investors expect further depreciation foreign investors withdraw funds, exporters delay dollar conversions, importers rush to buy dollars, and speculators intensify pressure.
• This creates a vicious cycle where expectations themselves accelerate depreciation.
• Economists explained such “overshooting” behaviour, where currencies move beyond equilibrium values in the short run.

Why Does Depreciation May Not Boost Exports Much?

• The textbook assumption that a weak currency automatically boosts exports is limited in India’s case because:
  • Indian exports are highly import-intensive.
  • Inputs such as crude oil, intermediate goods, and machinery become costlier.
  • Inflation erodes competitiveness gains.
• Moreover, if many emerging market currencies weaken simultaneously against the dollar, relative export competitiveness changes little.
• Thus, depreciation imposes immediate costs on households and firms without guaranteeing export gains.

RBI’s Policy Approach:

• The RBI maintains that exchange rates should remain market-determined, intervention is only to smooth volatility, and no fixed exchange rate target exists.
• India still possesses substantial forex reserves, credible monetary institutions, and relatively stable macroeconomic indicators.
• The IMF’s Integrated Policy Framework (IPF) also recognises forex intervention as a legitimate tool for emerging market economies during periods of excessive volatility.

Way Forward for India:

• Allow: Gradual market-driven adjustment while preventing speculative volatility.
• Strengthen: Long-term capital inflows through manufacturing and technology reforms (globally attractive AI and advanced-tech investment opportunities).
• Reduce: Import dependence, particularly in energy and critical intermediates.
• Expand: Export diversification and competitiveness under initiatives like “Make in India”.
• Deepen: Domestic financial markets to reduce vulnerability to external shocks.
• Maintain: Adequate forex reserves as a buffer against global uncertainty.

Conclusion:

• India should avoid both extremes — neither rigidly defending the rupee nor allowing disorderly depreciation. A calibrated strategy is essential.
• Ultimately, exchange-rate stability cannot rest solely on RBI intervention. Sustainable rupee strength will depend on improving India’s structural competitiveness, external resilience, and investor confidence in the long run.