Introduction to the Rupee’s Recent Performance
The Indian rupee recently crossed the Rs 90 per US dollar threshold for the first time, marking a significant milestone in its steady decline over the past year. This decline can be attributed to several factors, including foreign investor pullbacks from Indian equities and reduced export competitiveness due to US tariffs. Despite this, top economic officials have adopted a calm approach, signaling that the situation is under control.
Understanding the RBI’s Stance
Reserve Bank of India (RBI) Governor Sanjay Malhotra has clearly stated that the central bank does not target specific price levels or bands for the rupee. Instead, the RBI allows market forces to dictate the currency’s value. Chief Economic Adviser V. Anantha Nageswaran has also echoed this sentiment, asserting that the government is not concerned about the depreciation. He predicts that the situation will improve in 2026 and will not negatively impact inflation or exports.
The Impossible Trilemma Framework
The RBI’s approach is based on a core economic principle known as the impossible trilemma. This concept, first articulated by economists Robert Mundell and Marcus Fleming, states that a country cannot simultaneously maintain free capital flows, an independent monetary policy, and a fixed exchange rate. As a result, countries must choose two out of these three objectives. India has strategically opted for monetary policy independence and capital account openness since its economic liberalization in the 1990s.
Managed Float and RBI Interventions
While India officially operates a market-determined exchange rate system, it functions as a "managed float" regime. The RBI intervenes in foreign exchange markets not to defend a specific rupee level, but to curb excessive volatility. These interventions can include spot market operations, selling dollars when the rupee weakens sharply, and forward market operations or swap operations to manage liquidity and premiums. As of January 2, 2025, India held approximately $686.8 billion in foreign exchange reserves, providing the necessary ammunition for these interventions.
Strategic Rationale for Flexibility
Allowing the rupee to depreciate, rather than defending arbitrary levels, serves multiple purposes. It helps preserve valuable foreign exchange reserves for genuine crises, enhances export competitiveness by making Indian goods cheaper in dollar terms, and critically, maintains the RBI’s autonomy to set interest rates according to domestic economic needs. A flexible exchange rate also makes speculative bets riskier, deterring one-sided currency movements. The rupee’s depreciation is seen not as a failure, but as a deliberate policy choice within the constraints of the impossible trilemma.
Conclusion
In conclusion, the Indian rupee’s decline is a result of various economic factors, but the RBI’s approach is guided by the impossible trilemma framework. By allowing the rupee to fluctuate, the RBI is able to maintain its independence in setting monetary policy, preserve foreign exchange reserves, and enhance export competitiveness. This approach may seem counterintuitive, but it is a strategic choice that prioritizes the country’s long-term economic stability and growth. As the Indian economy continues to evolve, it will be important to monitor the rupee’s performance and the RBI’s interventions to ensure that the country remains on a path of sustainable economic development.
