RBI Vows to Steady 'Undervalued' Rupee After It Hits Five-Month Low

The Reserve Bank of India (RBI) said on Wednesday it would ensure that the “undervalued” rupee finds its correct level, after the currency slid to a five-month low of 96.8450 per dollar. The central bank also raised its policy rate by 25 basis points, its first tightening since February 2023, but the rupee still weakened as foreign capital flowed out of Indian markets.

Rupee Slides Despite Rate Hike

The rupee ended the day at 96.7750 per dollar, down 0.4% from the previous close of 96.42, according to The Economic Times. It is now within striking distance of its all-time low of 96.96, reached on May 20, and has lost 7% of its value so far this year. The currency's intraday fall to 96.85 prompted the RBI's post-policy remarks.

The RBI raised the policy rate by 25 basis points on Wednesday, the first such increase since February 2023. It also revised up its inflation and growth projections for the fiscal year 2027 (FY27), though the excerpt did not provide the specific figures. Higher interest rates typically strengthen a currency by offering better returns to overseas investors, but persistent outflows of foreign capital from Indian markets kept the rupee under pressure.

Governor Points to 'Undervalued' Rupee

RBI Governor Sanjay Malhotra said the rupee is undervalued in terms of the real effective exchange rate (REER), a measure that compares a currency's value against a basket of other currencies after adjusting for inflation. He added that the market could be irrational in the short run. “We will ensure the rupee stabilises and finds its correct value. We will support the rupee's orderly movement,” Malhotra said at the post-policy media interaction, reacting to the rupee's intraday fall to 96.85.

The governor's comments suggest the central bank is prepared to intervene to smooth volatility rather than target a specific exchange rate. The RBI's stance comes as the rupee faces dual pressures: a stronger dollar index and withdrawals of debt and equity investments by foreign investors, according to Bank of Baroda chief economist Madan Sabnavis. “It's likely to be a factor of stronger dollar index and withdrawal of debt and equity investments by foreign investors,” Sabnavis said.

Intervention Tools and Market Reaction

Traders said the central bank intervened in the foreign exchange market to cap the fall. The RBI likely conducted dollar-rupee sell-buy swaps to absorb surplus liquidity from the inter-bank market, according to The Economic Times. These swaps involve selling dollars for rupees in the spot market and buying them back in the forward market, which can help manage cash conditions without directly altering the central bank's foreign exchange reserves.

The intervention pushed the one-year forward premium up to 3.82%, its highest in six months. The three-month forward premium rose to 4.95%, while the six-month premium rose to 4.4%. A forward premium is the difference between the spot exchange rate and the forward exchange rate, and a rise can indicate market expectations of future currency weakness or tighter liquidity.

Forex market consultant KN Dey said corporates were seen buying forward in panic. “It's also rare for the rupee to sharply weaken on a day when the RBI tightens policy rate,” Dey added. The combination of a rate hike and a falling currency is unusual because higher rates usually attract foreign capital and support the exchange rate.

What to Watch

The RBI's commitment to ensuring the rupee finds its “correct” level leaves open how aggressively it will intervene and whether it will use further rate hikes or other tools. The central bank has not provided specific guidance on future rate moves or the scale of its interventions. For now, the rupee remains vulnerable to global dollar strength and capital flows, with the all-time low of 96.96 in clear sight.

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