India’s new Reserve Bank of India (RBI) Governor, Sanjay Malhotra, faces a critical choice on managing the rupee’s exchange rate: maintain the tightly controlled approach of his predecessor or adopt a more flexible stance as the dollar continues to strengthen.
Under former Governor Shaktikanta Das, the RBI sought to minimize rupee fluctuations, providing predictability for foreign investors and domestic stakeholders. However, this policy has drawn criticism for allegedly hampering export competitiveness and tethering the rupee to a de facto crawling peg against the dollar. Since Malhotra’s appointment, signs of increased volatility have emerged, with the rupee’s fluctuation reaching a one-year high in December.
The rupee has also come under pressure from a widening trade deficit, reduced net foreign direct investment (FDI) inflows, and a surging dollar. These challenges have pushed the currency closer to the 86-mark, following a series of record lows.
Export competitiveness and policy implications
A key issue is the rupee’s real effective exchange rate (REER), which hit a historic high of 108.14 in November, signaling overvaluation. Analysts suggest that a controlled depreciation of 2-3% is necessary to align the currency with long-term fundamentals and support export competitiveness.
Meanwhile, the RBI’s foreign-exchange reserves have dropped from a record $705 billion in September to $640 billion in late December, partly due to forward contract settlements and market interventions. This erosion highlights the challenges of sustaining the previous regime’s interventionist policies.
Market speculation suggests that the new RBI leadership may lean toward a less interventionist approach, allowing the rupee greater flexibility to respond to market forces. Such a shift could help mitigate risks associated with excessive reserve depletion and tighten monetary conditions. However, maintaining a balance between stability and flexibility will be critical as the RBI navigates persistent external pressures.
The coming months will reveal whether the RBI embraces a recalibrated policy under Malhotra or continues to prioritise currency stability in a volatile global economic environment.
