But for the RBI's management, rupee would have been far more volatile

Global shocks from pandemics to wars are reshaping currencies and capital flows, raising questions on RBI's role and India's external stability strategy

It appears the world has been moving from one disruption to another since the Covid-19 pandemic. As recovery began, Russia’s invasion of Ukraine in February 2022 disrupted supply chains again and increased geopolitical tensions. The invasion was accompanied by Western sanctions on Russia, an important energy supplier. Meanwhile, inflation became a challenge for most major central banks, driven partly by pandemic-induced supply chain disruptions and partly by excessive policy accommodation. The United States Federal Reserve, for instance, raised policy interest rates by over 5 percentage points between March 2022 and July 2023. Other major central banks made similar moves, resulting in significant volatility in global currency markets.

 

Before the world could return to normalcy, the US brought Donald Trump back to the White House. Mr Trump came with a determination to upend the global order in every sense of the term, to make America great again. His so-called reciprocal tariffs increased global economic uncertainty. India was targeted with additional punitive tariffs for importing Russian oil. While India and the US arrived at a trade agreement early this year, the US Supreme Court declared reciprocal tariffs illegal, significantly reducing the effective tariffs. However, tariffs are central to Mr Trump’s agenda, and he is working to bring them back under different laws. Again, before things could settle, the US, along with Israel, launched an attack on Iran. While the geopolitical implications of the Iran war will unfold over time, it has created enormous uncertainty for India and the world.

 

While trade disruptions and supply chain realignment warrant a comprehensive policy response, global shocks most immediately impact capital flows and currency movements, which tend to trigger policy debates, as is the case now. Several commentators, including on this page, have argued that the Reserve Bank of India (RBI) should let the rupee fall. There is merit in the argument. India’s balance of payments position has deteriorated, and a weaker currency will help restore the balance by making Indian goods and assets cheaper for foreigners. But it is worth debating whether the RBI should completely stay away from the currency market as is being argued. A recap of events since 2020 helps in this context.

 

Recent record: The Indian rupee depreciated by about 7 per cent against the US dollar between January and mid-April 2020 due to pandemic-related uncertainties. In March 2020, foreign portfolio investors sold Indian stocks and bonds worth over $15 billion. However, the tide turned quickly with proactive policy accommodation across the world. The rupee recovered, though its rise was restricted as the RBI accumulated reserves. It added about $120 billion to its reserves in 2020. In 2022, when central banks, including the Fed, raised interest rates, there was pressure on the rupee for obvious reasons. It fell by over 11 per cent during the year, despite the RBI’s interventions. Foreign exchange reserves came down by about $100 billion in the first nine months of 2022. The RBI later rebuilt its reserves, which crossed $700 billion in 2025.

 

In financial year 2025-26, owing to trade tensions, the rupee fell by about 10 per cent. Since the beginning of 2020, the rupee has fallen from about 71.2 against the dollar to about 94. Thus, it is hard to argue that the RBI is not letting the rupee adjust. In fact, the trade-weighted 40-currency real effective exchange rate is showing that the rupee is undervalued, which would be helpful in the present circumstances. The stated policy of the RBI is that it does not target any level and only intervenes to reduce excess volatility. As recent history clearly shows, had the RBI stayed out of the market, the currency would have been far more volatile. It is thus worth asking whether the Indian economy would have been better off had the RBI stayed away from the market all this time. The RBI did follow a largely hands-off approach in the years after the global financial crisis. It did not end well, and India faced a near-currency crisis in 2013. It had to incentivise deposits from non-resident Indians to stabilise the rupee. Such recurring conditions are unlikely to inspire confidence in the Indian economy.

 

Revisiting economic assumptions: Given the recent history and prospects, another important aspect needs attention. Indian policymakers have long assumed that the country can sustainably run a current account deficit (CAD) of around 2-2.5 per cent of gross domestic product (GDP), with foreign capital inflows of this magnitude supplementing domestic savings. The availability of foreign savings is also built into the Fiscal Responsibility and Budget Management framework. Since financing even a modest CAD worth about 1-1.5 per cent of GDP is becoming challenging, such assumptions may need to be revisited. In this regard, it is also worth noting that the budget deficit in the US has structurally moved to a higher level, which could appropriate more global savings and increase the cost of foreign capital. Thus, for greater external stability, India needs to boost domestic savings, and the general government budget deficit needs to be aligned with the available pool of financial savings.