Saving The Rupee Without Suffocating Growth

The Reserve Bank of India faces a tough choice: support growth through lower interest rates or stabilise the rupee to restrict capital flight. With inflation still a concern, foreign investors retreating, and rising global uncertainties, striking the right balance has never been more challenging.

The latest 25 basis-point rate cut by the Monetary Policy Committee was in line with the government’s push to revive consumption. More easing would risk further foreign institutional investor selling. The central bank’s next moves will test its ability to safeguard macroeconomic stability. 

Foreign investors have offloaded over ₹1.2 trillion this calendar year alone, lured by soaring bond yields, a resurgent dollar, and corporate earnings momentum in the US. Domestic equities, already trading at frothy valuations, have amplified the exodus. Barring December 2024, foreign investor outflows have been consistent in both debt and equity markets, pushing the rupee to record lows against the dollar.

While a narrowing trade deficit—driven by lower oil, gold, and non-oil, non-gold imports—offers some relief, it hasn’t been enough to offset capital outflows. The Balance of Payments outlook remains fragile, with muted foreign direct investment and a significantly weaker surplus expected in 2025 compared to $64 billion in 2024.

The Reserve Bank of India’s core mandate is price stability, with an inflation target of 4-6%, but the currency’s depreciation complicates that goal. A weaker rupee makes imports costlier, particularly commodities such as crude oil, feeding into persistent core inflationary pressure. The central bank has stepped in through foreign exchange market interventions—$60 billion deployed in 2024—but the rupee remains vulnerable to external shocks. At the same time, liquidity management is a delicate act—excess fuels inflation, while a squeeze hampers credit growth.

Structural weaknesses loom larger. India’s corporate bond market remains underdeveloped, leaving businesses over-reliant on banks. Reviving the asset monetisation programme and pushing privatisation and disinvestment could play a crucial role in attracting long-term capital flows.

While the Centre’s fiscal prudence in the recent Budget is commendable, state-level profligacy persists, undermining investor confidence. While public spending has helped, growth will remain sluggish unless private capex picks up pace. 

The rupee will likely remain under pressure as long as the US dollar stays strong and global uncertainties persist. However, with proactive forex management, structural reforms, and calibrated monetary policy, the Reserve Bank of India can limit volatility without compromising economic momentum.

The central bank’s real test in 2025 transcends inflation targeting. It must stabilise the rupee to retain foreign investors while ensuring growth isn’t collateral damage. Achieving these demands more than reactive rate tweaks: deepening capital markets, reviving disinvestment, and enforcing fiscal discipline across states are non-negotiables. Balancing these forces will define the RBI’s legacy in the months ahead.