Amid significant USD outflows of nearly ₹1 lakh crore and a strengthening dollar, the Indian
rupee faces mounting pressure. The RBI has shifted its strategy to the Non-Deliverable
Forward (NDF) market, aiming to stabilize the rupee without depleting reserves. This
approach highlights the broader economic challenges India currently navigates, compounded
by external pressures like a potential yuan devaluation.
Economics
The USD is strengthening against all currencies, including the INR, driven by massive
outflows of USD from India in the last two months, totaling close to ₹1 lakh crore. Naturally,
this has increased the demand for USD, putting significant downward pressure on the INR.
The rupee’s depreciation is straightforward—more buying of USD leads to a weaker INR.
A potential devaluation of the Chinese yuan adds another layer of complexity. Such a move
could make Chinese goods cheaper, undermining India’s export competitiveness and
increasing its trade deficit with China. This would exert further downward pressure on the
rupee, necessitating additional RBI interventions.
RBI’s Traditional Strategy
The RBI typically counters such volatility by supplying USD into the market. With forex
reserves of approximately $600 billion, it has the capacity to absorb increased USD demand,
which softens the rupee’s fall. Similarly, during periods of high USD inflow, the RBI buys
USD to prevent the rupee from appreciating too much.
This strategy ensures the rupee’s gradual depreciation over time, but never a return to earlier
levels of ₹75 or ₹80 to the dollar. Over the long term, this cyclical process helps the RBI earn
profits by buying USD when it weakens and selling when it strengthens. However, in the
short term, this results in a dip in FX reserves during USD appreciation, which is often
reported as negative news (“India’s FX reserves dip by $XXXX”).
A Shift to Derivative Markets
What’s different this time is the RBI’s decision to intervene in the Non-Deliverable Forward
(NDF) market instead of selling USD directly in the spot market. NDF contracts are cashsettled derivative instruments that allow parties to exchange the difference in value between
contract price and spot price without actual currency delivery.
This strategy stabilizes the INR in a similar way to cash market interventions but without
reducing the RBI’s forex reserves. By focusing on the forward market, the RBI can scale its
interventions more significantly, amplifying its impact on the rupee’s depreciation.
The RBI’s strategy may also reflect a readiness to align the rupee’s weakening with any yuan
devaluation. This alignment could mitigate export competitiveness concerns, particularly
given broader risks like potential U.S. tariff policies on Chinese goods.
Trade-Offs of NDF Strategy
However, this approach comes with a financial cost. At settlement, if the spot price of USD is
higher than the forward rate, the RBI will have to book losses and pay the difference. While
FX reserves remain untouched, these losses could accumulate significantly.
It’s crucial to understand that even with $600 billion in reserves, the RBI cannot
fundamentally alter USD’s strength, given the global FX market’s daily turnover of $5
trillion. Large arbitrage funds would absorb such reserves within days. The RBI’s goal isn’t to
“beat” the USD but to stabilize the rupee and slow its depreciation, even at the cost of shortterm losses.
Economic Challenges and Risks
Underlying this intervention are broader concerns about India’s economy. GDP growth
slowed to 5.4% in Q3 2024, its weakest in two years, missing all projections. Loan growth,
which was at 20% in May, fell to 11.1% in November, reflecting a sharp slowdown in
shadow banking activities. Additionally, inflation-adjusted urban wages contracted for the
first time since the pandemic, and consumer spending has declined.
Major companies like Maruti Suzuki and Hindustan Unilever have reported weaker earnings,
citing reduced middle-class demand. These signs indicate deeper vulnerabilities, exacerbated
by global pressures such as a strengthening USD and synchronized economic downturns.
Following Trump’s election, fears of increased U.S. tariffs on Chinese goods have also
influenced Asian currency dynamics, with the rupee hitting all-time lows. Market reactions
underscore the need for the RBI to maintain a flexible approach to currency management,
balancing internal economic challenges with external shocks.
Looking Ahead
The RBI’s current strategy underscores the complexity of balancing currency stability with
economic challenges. While the long-term growth story for India remains positive, much
depends on Q3 results. If numbers disappoint, a government stimulus involving tax cuts and
increased spending could be on the horizon to retain growth momentum.
If the yuan continues to weaken, analysts predict the INR could breach ₹85 against the USD
within the next year. To manage this, the RBI may allow gradual rupee depreciation to
maintain competitiveness, especially as India seeks to attract businesses relocating from
China. Even at slower growth rates, India remains one of the fastest-growing major
economies. As domestic conditions improve, USD inflows are expected to resume, providing
additional support for the rupee.