The Indian rupee has emerged as one of the weaker emerging market currencies this year, pressured by the country’s heavy dependence on oil imports at a time of historic Middle East supply disruption, large foreign investor outflows and a robust U.S. dollar supported by safe-haven demand.
In recent weeks, the government has also urged households to embrace temporary belt-tightening measures to reduce the economy’s exposure to the geopolitical shock. Among the recommendations were cutting fuel use by working from home and relying more on public transportation, as well as holding off on purchases of gold.
Currency moves have been notable. The rupee fell to a record low of 96.305 against the U.S. dollar on Friday before recovering some ground to close at 95.700. Year to date, the currency is down roughly 6.5%. Market participants say the decline would likely have been steeper without active measures by the Reserve Bank of India to support the currency.
Research from Capital Economics argues that, from a macroeconomic perspective, the RBI could allow further depreciation without triggering large-scale damage. Shilan Shah, deputy chief emerging markets economist at Capital Economics, points to the central bank’s balance-sheet tools and the relatively robust headline reserve position as reasons the rupee’s path has been smoother than it might appear.
"The depreciation (in the rupee) this year would have been larger if it weren’t for intervention from the RBI. That doesn’t immediately show up in overall FX reserves, which still look healthy at almost US$700bn. Instead, the RBI’s growing forward book - now standing at around US$100bn, from US$68bn at the start of the year - has enabled it to manage the rupee’s decline," Shah said.
Shah and the research note underline two policy levers the RBI has already deployed: direct intervention in the spot market and a sizable increase in its forward book, which serves to smooth volatility and provide time for adjustment. Those actions have helped shield headline reserves while allowing the central bank to influence near-term currency moves.
However, the research also suggests that if depreciation pressures continue, the RBI would likely respond with a monetary policy tightening. Other emerging markets have moved in that direction recently; for example, Indonesia has already raised rates, and Chile and Poland are widely expected to follow suit.
On the inflationary consequences of a weaker rupee, Capital Economics provides a measure of the expected pass-through, arguing that direct effects on headline inflation are relatively modest. As an approximate rule of thumb cited in the research, a 10% depreciation of the rupee would raise headline inflation by about 0.5 percentage points over the following three to four quarters.
Shah noted that while such a pass-through is not negligible, it is small compared with other inflation drivers currently at work in India - notably higher pump prices for fuel, rising food inflation and broader supply-chain disruption. As a result, the research predicts that headline inflation will likely exceed the upper bound of the RBI’s 2-6% target range regardless of further rupee weakness.
The analysis also highlights structural factors that reduce the risk of severe macro stress from currency depreciation. India’s relatively low stock of foreign-currency-denominated debt limits the exposure of both corporations and the sovereign to exchange-rate moves, lowering the probability of defaults tied directly to currency moves.
Moreover, a softer rupee could offer a competitive tailwind for exporters. According to the RBI’s own estimates cited in the note, a 5% depreciation in the rupee could boost economic growth by around 0.25%.
In sum, the recent weakness in the rupee reflects a mix of external shocks and capital flows, with domestic policy responses blunting what might otherwise have been a larger decline. The Capital Economics research frames a policy choice for the RBI - whether to continue active defence of the currency or to tolerate a further depreciation that would have only limited macro fallout while supporting export competitiveness and leaving inflationary pressures mainly driven by other factors.