Rupee’s Turn from Shock Absorber to Amplifier in Oil Shock

The rupee once again finds itself at the centre of a global shock. Over the past 18 months, it has had to absorb a succession of external headwinds, from tariff risks to AI-driven uncertainties. Now an energy-supply shock threatens to reprice India’s external balances and trigger a rotation in global portfolios—from oil importers towards oil exporters and safe-haven assets.

Since early 2025, the rupee has weakened by around 9%, with almost 3% of that move packed into the last few weeks. We are not unique: the rupee’s path broadly tracks other net oil importers such as the Korean won, Thai baht and Japanese yen. The common thread is higher crude and a stronger dollar.

But the macroeconomic implications of currency weakness depend critically on the nature of the underlying shock. In 2025, when tariffs were the dominant risk, a weaker rupee could be rationalised as a partial buffer—offsetting lost export competitiveness from tariff differentials. In that configuration, the rupee was a shock absorber.

In an energy price shock, that logic flips. With oil prices elevated, each incremental depreciation raises the domestic cost of energy imports, widens the current account deficit, and adds to both inflationary and growth risks. RBI estimates suggest that a 5% depreciation of the currency lifts inflation by around 35 bps. In isolation, that pass-through appears modest. But layered onto a terms-of-trade shock, it becomes materially more consequential. Left entirely to market forces in this backdrop, the exchange rate can turn from buffer to amplifier.

Policy strategy is further complicated by geopolitical fog. The narrative around the current conflict shifts by the day, with no clear sense yet of how long the disruption will last. If the conflict were to de-escalate relatively soon, a policy of moderate, managed depreciation—through calibrated intervention—would make sense. Smoothing the move in the rupee would limit the near-term pass-through from spikes in energy prices and help anchor expectations about the pace of future depreciation. It would also reduce the payoff to one-way speculative bets.

Equally, such a strategy builds in optionality if the conflict instead escalates or drags on. The “threat” of credible intervention tends to slow the speed of adjustment in the exchange rate, spreading depreciation over time in a way that the system can absorb, rather than allowing abrupt overshooting that often feeds on itself and can prove costly to reverse.

The objective is not to heroically and endlessly “lean against the wind”, but to lean just enough to reduce volatility and keep the exchange rate aligned with fundamentals.

In practice, this is close to what the RBI has successfully done over recent months: periods of heavy intervention followed by phases when the rupee is allowed to adjust, and then a repeat of this cycle as global conditions evolve. This “hot (heavy intervention)–cold (adjustment phase)–repeat” approach also aligns with an inflation targeting regime, where the exchange rate is not the target per se but seen as a channel of transmission.

Reserve Trade-off
The experience of the Russia–Ukraine war is instructive in this regard. While Brent crude surged above $120 per barrel in early 2022, the rupee depreciated in a controlled manner—roughly 0.5–1.5% month-on-month between March and June. The RBI intervened actively during this phase, smoothing volatility and limiting pass-through at a time when elevated oil prices posed acute risks to inflation and external balances. Through 2022, reserves fell from roughly $630 billion to $570 billion (import cover of 9 months)—consistent with using reserves as a buffer, not a sacrosanct stockpile.

That history frames today’s market question: Does the RBI have enough “ammunition” to run a similar playbook again? Headline reserves of about $710 billion translate into an import cover of roughly 11.2 months.  Although adjusting for the short forward book would effectively bring this down below 10 months, which explains some of the recent unease.

Yet, focusing narrowly on import cover risks underestimating the broader external buffer.

A broader question of “reserve ammunition” must be assessed against net external flows—not just gross import obligations but also exports and remittances that generate steady dollar inflows. In that sense, future payment obligations must be evaluated alongside future receivables, offering a more complete picture of external resilience.

Making these adjustments, RBI’s ammunition seems well-positioned in the current storm.

The real policy choice is about sharing the burden of the shock between the rupee and reserves. Letting the exchange rate bear the full strain in the middle of a sharp energy spike offers limited payoff if it risks unmooring inflation expectations and unnecessarily tightening domestic financial conditions.

Central banks cannot optimise for a hypothetical future crisis; they respond to the distribution of risks they can see and the buffers they have. In the current episode, a combination of measured intervention and a flexible—but not hands-off—exchange-rate regime offers the most credible path to navigating the global energy shock, while minimising collateral damage to growth and inflation.