On Wednesday, the Indian rupee plunged to a historic low of 96.96, dangeroulsy skirting the 97-level against the dollar.
It has weakened over 6% since the Iran war began on February 28, lost nearly 7.8% so far in 2026 and about 13% y-o-y. Going by the current run-rate, markets have begun pricing in 100 per dollar this year.
The ongoing rupee depreciation is driven by a combination of factors including elevated global crude oil prices, persistent foreign fund outflows, strengthening dollar, rising US Treasury yields and so on. Given the exchage rate's sharp correction, currency traders expect the RBI to mount its white horse and come blazing with both hands to defend the rupee. In contrast though, the central bank's interventions have been rather limited simply to smoothen volatility.
But as the domestic currency continues to breach new lows, opinion is getting fiercer over what the RBI should or shouldn't do.
If some insist the central bank to raise rates to attract foreign capital and prevent inflationay build-up, others argue otherwise. If the first camp stresses on raising dollars through NRI deposit schemes and some such measures, the latter dismiss these instruments as a 'transfer to rich NRIs' as they carry steep interest.
Those batting for dollar bonds aren't doing so without reason. There have been precedents when India mobilized about $26 billion during the 2013 taper tantrum period via NRI deposit swaps to spur dollar inflows. Prior to this during 1999 too, RBI raised $4.2 billion issuing Resurgent India Bonds to NRIs. Per estimates, rolling out similar measures may fetch as much as $50 billion, much higher than the current foreign capital outflows.
The counter view, however, is that RBI should hold firm as this isn't 2013 when India was one of the Fragile Five economies. Instead, the country's fundemantals are strong, inflation isn't running amok in double digits like it did in 2013 and so the economy can absorb some inflationary pressure accompanying the rupee depreciation. In fact, former Niti Aayog vice chairman Arvind Panagariya urged RBI to not let the pshychological barrier of 100 per dollar determine its policy response. "100 is just a number, like 99 and 101," he reasoned adding that we'll have to eventually cross the 100 per dollar barrier in due course.
So defending the rupee fall will only bleed forex reserves, while the dollar-denominated bonds or high-interest dollar-denominated NRI deposits will prove to be costly, he explained.
Traditionally, RBI's first line of defence to stem rupee's fall is to sell dollars from forex reserves. Since February 28, it sold over $38 billion. Currently, forex reserves stand at about $688 billion, and excluding the $65 billion net short forward positions, usuable reserves are about $623 billion. These may or may not be enough. While a 4-5% annual rupee depreciation is in line with fundamentals, India would need a forex reserve buffer of at least $1 trillion for robust intervention capacity, according to former RBI Governor Michael Patra.
That said, the more the RBI intervenes, the lesser firepower it will have, and could compound external shocks. So some economists want the RBI to not intervene too much and let the rupee find its own level.
And even if RBI decides to aggresively sell dollars to retain rupee at 90 or so, it may not help as dollar sales drain rupee liquidity affecting commercial banking. So on Wednesday when rupee touched a record low of 96.96, instead of exhausting dollars from forex reserves, RBI announced a $5 billion USD/INR buy-sell swap scheduled for May 26, with a three-year tenor.
The move will likely inject Rs 42,000-43,000 crore liquidity into the banking system and boost dollar reserves. However, such dollar swaps come at an additional cost as banks sell dollars to RBI in exchange for rupee liquidity with an agreement to buyback the same amount of dollars at maturity but at spot price plus premium. For now though, the announcement helped rupee regain 70 paise to 96.30 on Thursday, but the question is if more such swaps are the right measure to arrest the currency weakness.
As some argue, rupee is currently under a speculative attack, not due to higher oil prices, but largely because of FPIs dumping Indian equities and bonds. For the first time, FPIs have been net sellers of Indian equities for two consecutive years (FY25 and FY26) since the data compiling began in FY99. One of the reasons for this persistent outflows is taxation.
Currently, foreign investors pay tax on all captial gains made in India and unlike other major economies where capital gains are taxed in the country of residence not the country in which you buy and sell, we deduct tax at source. So if the idea is to strengthen the rupee, some insist on eliminating capital gains tax and lowering or foregoing TDS altogether on interest on listed bonds for foreign investors. The government was reportedly considering tax sops for FIIs though there has been no official word yet.
Even if there's one, rupee may continue to depreciate until oil prices and shortages stabilize. With brent prices touching $110-$120 per barrel, India's import bill is now pegged in excess of $240 billion this fiscal as against roughly $160 billion the previous fiscal. As crude prices remain volatile, some fear India may be staring at an oil-driven stagflationary snarl regardless of whether the oil shortage is short-lived or prolongs. So they insist the right response at the moment is to hike rates.
RBI's next monetary policy meeting is scheduled for June 3-5. In April, it held benchmark repo rate unchanged at 5.25%. Higher rates can attract foreign capital inflows as the interest rate differential between the US and India widnes. Right now, it narrowed to a near decade low. With US bond yields inching closer to 5% and given India's 5.25%, a mere 25 bps spread won't be enough to attract overseas capital.
Above all, weakening rupee risks widening India's balance of payments deficit as import costs, particularly, crude oil, gold and electronics rise faster than exports. Though fears of a BoP crisis aren't real given India's strong macroeconomic fundamentals, a crude oil reset above $120 per barrel changes the equation altogether.