Understanding The Rupee’s Fall With Veteran Regulator Mahalingam

The rupee’s depreciation has sparked intense debate, with concerns over policy missteps, market interventions, and the broader economic impact. To break down the complexities, BasisPoint Insight spoke to G. Mahalingam, a seasoned market regulator with 34 years at the Reserve Bank of India, including as chief dealer of foreign exchange and later as Executive Director overseeing entire market operations. He later served as a whole-time member at SEBI and now sits on the board of LIC and other financial institutions.

In this two-part interview, Mahalingam unpacks the real drivers of the rupee’s movement. He argues that the RBI’s recent reluctance to let the rupee adjust naturally may have created pent-up pressure, which is now unwinding. He emphasises the importance of the real effective exchange rate over nominal stability and warns against short-sighted interventions that merely delay inevitable market corrections.

Mahalingam also shares an insider’s perspective on RBI’s intervention tactics, including its efforts to protect psychological levels. He discusses the risks of taking on deep-pocketed speculators in the NDF market, where a misstep could embolden global players to challenge the RBI. Finally, he lays out what he would advise today’s RBI leadership, given the mounting pressures on currency stability and monetary policy.

The conversation, led by Kalyan Ram, founder of BasisPoint Insight, provides a rare behind-the-scenes look at how India’s central bank manages its currency and what challenges lie ahead.

Here are the edited excerpts:

Why is the rupee depreciating?
Rather than rupee depreciation, I’d call it dollar appreciation. The dollar index has been on a strong uptrend for several months. The rupee remained steady for a while, with the RBI holding it in place, but this delayed adjustment is now playing out.

From October to February, the dollar index appreciated by about 6%, while the rupee depreciated by only 3.2%. There’s still some steam left in this move.

Other factors at play include foreign portfolio investor outflows—investors may see Indian stocks as fully valued or even overvalued, prompting them to seek better returns elsewhere. Then, there’s the interest rate differential. The 10-year G-Sec yield is around 6.8%, while the US 10-year yield is near 4.5%, leaving a gap of about 230 basis points. But with forward premiums hovering around 2.2-2.5% levels, hedged bond investments aren’t as attractive. All these factors are pushing the rupee lower.

Market estimates suggest the rupee could touch 90–92 soon. Should that be a concern from an importers', FPIs' perspective, and for macro and financial stability?
Personally, I think these are the kinds of situations the RBI encounters regularly. The key question is: Where is the rupee’s equilibrium level based on the real effective exchange rate, and where do we stand today?

If the rupee moves to 90–92, I don't see it as an alarming development—provided the move happens gradually and in an orderly manner. REER has long been a useful framework for gauging fair value, though it isn't a rigid target. A rupee that broadly aligns with its equilibrium rate strengthens long-term macroeconomic stability.

That said, the speed of depreciation matters. If the rupee weakens to 90–92 within two to three weeks, it would be severely disruptive. Many importers and external commercial borrowers don’t disclose their positions, but they will feel the heat. Unhedged positions would lead to steep losses, forcing them to absorb significant costs.

There’s a big difference between the rupee reaching 90–92 in a few weeks versus over six months. A rapid move would cause market turmoil—perhaps even panic selling—whereas a gradual adjustment gives businesses time to hedge their exposures and manage risks.

For FPIs, rupee depreciation is less of a shock. Many were already looking to exit due to high valuations and were merely timing their exits.

From a macroeconomic standpoint, a measured depreciation may actually be beneficial. With oil prices hovering near $70 per barrel, a 3–4 rupee decline would not significantly impact the balance sheet. The government must also adjust to a more flexible exchange rate rather than trying to hold levels artificially.

Some argued the RBI should have held rates steady to support the rupee, yet it cut rates on February 7. Was that the right call?
Absolutely. The RBI focuses on the growth-inflation balance, not the exchange rate when setting monetary policy. Growth needed a push, inflation wasn’t surging, and this was a good opportunity to start easing.

That said, the Governor has been cautious—not committing to further cuts until data supports them. That’s a smart approach. The focus remains on domestic growth dynamics, not currency concerns.

Some argue that the exchange rate acts as a release valve for financial and macroeconomic pressures. Do you think the rupee’s movement is reflecting deeper structural issues in the economy?
That’s an interesting way to look at it, but I wouldn't entirely agree that the rupee’s depreciation is a direct reflection of economic weakness. The Indian economy is in reasonable shape—not excellent, but certainly not in distress. If the rupee’s movement were a sign of macroeconomic instability, we would have seen broader stress indicators—such as severe capital flight, a sharp rise in bond yields, or an external financing crunch. None of that is happening.

Instead, I believe the rupee’s adjustment today is the result of a delayed correction. The previous RBI administration kept the exchange rate rock steady through persistent intervention, even when the dollar index was strengthening globally. By doing so, the RBI prevented the rupee from adjusting in real time to market forces, causing a build-up of pressure. Now, as the dollar remains strong and external conditions evolve, that pent-up pressure is being released.

This is a key distinction—it’s not that the rupee is suddenly collapsing due to economic fragility, but rather that the correction is happening in a compressed time frame, making it appear sharper than it otherwise would have been. Had the exchange rate been allowed to adjust gradually, we wouldn’t be seeing this sudden bout of depreciation.

That said, some pain is inevitable. Importers and companies with external commercial borrowings are feeling the pinch because they weren’t prepared for a quick adjustment. If depreciation had been spread out over the past year, they would have had more time to hedge or adjust their positions.

The previous RBI Governor was accused of pegging the rupee to the dollar by actively managing the exchange rate. Do you think that was a strategic choice?
There was certainly an effort to hold the rupee steady, but I wouldn’t go as far as to say it was an outright peg. If it were a peg, the RBI would have explicitly stated it and backed it with deeper intervention commitments. Instead, the central bank chose to intervene aggressively whenever volatility spiked, which gave the illusion of a pegged rate.

Why did the RBI do this? I think there were two primary reasons:

• Fiscal Stability and Inflation Control – A stable rupee helped the government manage its fiscal position. With India being a net importer, a depreciating rupee would have raised import costs—particularly for oil—affecting inflation and widening the fiscal deficit. By keeping the exchange rate steady, the RBI ensured that imported inflation remained contained. This was a tactical move to support overall macroeconomic stability.
• Managing External Perceptions – A controlled exchange rate helped maintain market confidence, particularly among foreign investors and rating agencies. Sudden volatility could have raised concerns about financial stability, triggering capital outflows.

While the approach had its merits, the cost of this strategy is now being felt. Delaying depreciation artificially inflated the rupee’s value, making exports less competitive and creating misaligned expectations in the market. When the correction finally came, it was more abrupt than it should have been.

Some believe the RBI may have done this to protect Indian firms that borrowed overseas or to assist companies raising external commercial borrowings. Do you think this was a factor?
I don’t think so. The RBI doesn’t craft policy to shield specific sectors or companies. The central bank operates with a broader macroeconomic focus, ensuring stability rather than favouring any particular group.

Keeping the rupee stable may have incidentally helped firms with overseas borrowings by making repayments more predictable. But to say this was an explicit motive would be an overstatement. The RBI’s primary concern is always financial stability, not corporate balance sheets.

Was the RBI also preparing for another taper tantrum-style event while building reserves and keeping the rupee steady?That’s a very plausible theory. Ever since the 2013 taper tantrum, the RBI has remained wary of speculative attacks on the rupee. There’s always a risk that if global conditions change rapidly—such as the US Federal Reserve tightening rates aggressively—emerging market currencies could face sharp volatility.

But here’s where the problem lies: preventing volatility in the short term doesn’t eliminate long-term risks. A nominally stable rupee can mask underlying pressures, and when the market finally forces a correction, it tends to happen in a disorderly manner.

In my view, the RBI’s previous approach miscalculated the trade-off. The best way to guard against a speculative attack is to allow the currency to adjust organically over time rather than trying to suppress movement artificially. Otherwise, when depreciation does happen, it occurs in a rush, inviting even greater speculation.

So, while the taper tantrum fear was valid, the strategy to defend against it may not have been optimal. A more measured depreciation path over time would have helped the rupee adjust without the sharp swings we see now.

Round-number thresholds, like 90 per dollar, serve as key anchors in forex markets. A decisive breach can spark speculative activity, complicating RBI’s efforts to restore order.

Let’s go deeper into RBI’s intervention strategy. The new Governor has said he doesn’t monitor day-to-day changes but focuses on broader trends. However, despite this, we saw a period when the rupee was moving freely, followed by sudden, large-scale intervention—reports suggest the RBI sold $10–15 billion over a couple of days. What do you think triggered this shift?
Intervention is never about responding to every small fluctuation in the market. The RBI usually acts when certain levels are at risk of being breached, particularly those that have psychological significance for traders.

In the forex market, round-number thresholds—like 90 per dollar—carry enormous weight. Traders, corporate hedgers, and large institutions often anchor their expectations around these numbers. If the rupee crosses such a level decisively, it can trigger a cascade of speculative activity, making it difficult for the RBI to restore order later.

This is likely why the central bank stepped in aggressively before 90 was breached. If the rupee had fallen past that level unchallenged, market sentiment could have shifted decisively against it, forcing the RBI to spend much larger sums to regain control. Instead, they chose to intervene early, absorbing some selling pressure to buy time—perhaps for a few months—before allowing further depreciation.

However, this type of defensive intervention is not meant to be a permanent defense. At some point, the market will push the rupee to its fundamental equilibrium, and the RBI will have to step back and let the market adjust. The goal here is simply to ensure an orderly depreciation rather than a sharp, panic-driven fall.

Did market players take advantage of this window of free movement before the intervention?
Absolutely. That’s how markets work. Traders and hedge funds constantly analyse central bank behaviour and adjust their positions accordingly.

In the weeks when the RBI allowed the rupee to move more freely, speculators likely took large short positions, betting on further weakness. As soon as the RBI intervened, those bets would have been closed quickly, with traders locking in significant profits.

At the same time, some market participants—particularly importers and businesses with foreign currency liabilities—would have been caught off guard. Those who didn’t hedge in anticipation of further rupee weakness might have faced sudden losses when the RBI pushed back against the depreciation trend.

The stop-go approach the RBI adopts is a delicate balancing act. It allows for some depreciation, but not so much that it triggers runaway speculation. However, the risk here is predictability—if traders figure out the exact levels where the RBI will intervene, they can game the system, reducing the effectiveness of interventions over time.

Given these constraints, does the RBI have the ability to control the rupee’s path fully?
Not fully—no central bank can. The global currency market is simply too large. India’s economy is becoming more integrated into global capital flows, meaning that external forces—US monetary policy, global risk sentiment, oil prices, trade imbalances—play an increasingly dominant role in determining the rupee’s value.

This is why the RBI does not aim to defend any specific exchange -rate level indefinitely. Instead, its role is to smoothen the volatility and prevent disorderly moves. A central bank’s worst nightmare is a sudden, uncontrolled depreciation, which could fuel capital outflows, panic in financial markets, and corporate distress.

The challenge is to intervene without creating one-sided expectations. If traders believe the RBI will always step in at certain levels, they will push their bets to those limits, effectively daring the central bank to act. This creates a moral hazard, where market participants take excessive directional bets, assuming the RBI will protect them.

To avoid this, the RBI uses a stop-go approach—allowing some depreciation, stepping in when needed, and withdrawing to let the market function. The key is unpredictability. If traders constantly second-guess whether the RBI will act, speculation will be kept in check.

That said, the fundamental truth remains—if macroeconomic conditions dictate a weaker rupee, no amount of intervention can hold an artificial level forever. The RBI’s job is not to resist this shift but to manage the transition in a stable and controlled manner. 

 

This concludes Part I of the interview.

In the second and final instalment, G. Mahalingam discusses the RBI’s high-stakes play in the non-deliverable forward market, where offshore speculators can test the central bank’s resolve. He says NDF intervention is both necessary and dangerous. Mahalingam also outlines his advice to the current RBI leadership, balancing intervention with market realities. 

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