A stronger rupee, shrinking dollar reserve: The balancing act facing RBI

Rupee has had a rough ride this year, sliding nearly 6% against the US dollar and hitting one record low after another. But after coming dangerously close to the 97-per-dollar mark, the currency has clawed its way back to around 94, helped by intervention from the Reserve Bank of India (RBI).Rupee had plunged to a record low of 96.96 in May and came close to breaching the 97 mark again earlier this month. It has since recovered around 2%, with the RBI stepping in to cool dollar demand.Earlier this week, rupee strengthened by 82 paise to 94.96 per dollar on the interbank order matching system, gaining nearly 0.7% from its previous closing, in a single session.As rupee continues to face a series of factors weighing it down, geopolitics, trade issues, dollar demand and more, the central bank rolled out a support system for the currency. The measures include restrictions on cancelling and rebooking foreign exchange derivative contracts, tighter documentation requirements, a 20% foreign exchange risk reserve for specified transactions and a special dollar window for public sector oil marketing companies.So, now when rupee is finally back in the seemingly safer territory, can RBI breathe easy?Not quite.The recent rebound may have given the currency some breathing room, but the apex bank still has a tricky balancing act on its hands: keeping sharp swings in check without running down its foreign exchange reserves or making it more expensive for businesses to hedge against currency risks.(function(){function e(){window.addEventListener(`message`,function(e){if(e.data[`datawrapper-height`]!==void 0){var t=document.querySelectorAll(`iframe`);for(var n in e.data[`datawrapper-height`])for(var r=0,i;i=t[r];r++)if(i.contentWindow===e.source){var a=e.data[`datawrapper-height`][n]+`px`;i.style.height=a}}})}e()})();The central bank also has a sizeable reserve cushion. India’s foreign exchange reserves hit a record $785.71 billion in the week ended September 4, 2026, rising by $44.9 billion in a single week, the biggest weekly increase on record. The increase was attributed to inflows through the RBI’s special dollar swap scheme, launched in June, which had brought in $136.38 billion. The record inflows coincided with the rupee rising to a two-month high.However, the size of the reserves alone does not determine how far the RBI can go in defending the currency. It must weigh the impact of intervention against India’s external payment obligations, the effect on banking liquidity and the cost of hedging currency risks.Rupee under pressure - When RBI needs to step inIn layman terms, rupee’s value depends on how many people want to buy dollars and how many are willing to sell them. So when demand for dollars rises and supply falls, rupee comes under pressure.This year, rising oil prices and heavy selling by foreign investors in Indian equities have added to the pressure. Importers have also been buying dollars to protect themselves against a further fall in the currency, while exporters have been holding back their dollar sales.This creates a mismatch: importers need dollars to pay for goods bought abroad, but fewer dollars may be entering the market if exporters delay converting their foreign earnings into rupees. The result is greater demand for dollars, putting further pressure on the rupee.ICICI Bank, in a recent report, noted that this gap had added to dollar demand, while forward premiums had also risen in recent months.However, the RBI is not trying to keep rupee at one fixed level.Jyoti Prakash Gadia, managing director of Resurgent India Limited, told TOI that the central bank’s aim is to control sharp fluctuations in the currency, rather than defend a particular exchange rate.“There is no fixed exchange rate at which the RBI will have to act. According to the RBI’s official stance, its objective is to curb volatility rather than protect a particular level of the rupee,” the expert said.(function(){function e(){window.addEventListener(`message`,function(e){if(e.data[`datawrapper-height`]!==void 0){var t=document.querySelectorAll(`iframe`);for(var n in e.data[`datawrapper-height`])for(var r=0,i;i=t[r];r++)if(i.contentWindow===e.source){var a=e.data[`datawrapper-height`][n]+`px`;i.style.height=a}}})}e()})();An orderly fall driven by differences in inflation, oil prices or the dollar’s strength in global markets may not require intervention, he added. The case for action becomes stronger when panic grips the foreign exchange market, liquidity dries up, speculative positions become destabilising or depreciation begins to fuel inflationary expectations.How is RBI trying to cool dollar demand?Earlier this month, the RBI introduced five key measures to curb excessive hedging, tighten oversight and move some dollar demand away from the regular foreign exchange market.1. Restricting cancellation and rebooking of contracts: RBI has restricted the cancellation and rebooking of foreign exchange derivative contracts involving the rupee. Repeatedly cancelling and rebooking contracts can add to market activity. The restriction is expected to reduce such volumes, although it also makes hedging more expensive for importers.An ICICI Bank report said, “With the new measures, RBI has made it more expensive for importers to hedge. Also, the volume in the market should see a decline given cancellation and rebooking of contracts are not going to take place,”2. Cutting the limit for transactions without documentation: The threshold for certain foreign exchange derivative transactions that can be undertaken without establishing an underlying exposure has been reduced to $5 million from the earlier $100 million. The aim is to tighten oversight and curb dollar demand driven by expectations of further rupee depreciation rather than genuine business requirements.3. Tightening documentation requirements: The RBI has also tightened documentation requirements to prevent the same exposure from being hedged multiple times. This is relevant as importers seek protection against a weaker rupee while exporters hold back dollar sales, adding to the demand-supply imbalance. ICICI Bank expects the measures to bring hedging activity closer to equilibrium. Its report said, “All of these measures put together should ensure that the hedging ratio should move towards an equilibrium and thus cool off the demand for Dollars and thus the depreciation pressure on the currency,”4. Introducing a 20% foreign exchange risk reserve: The RBI introduced a 20% foreign exchange risk reserve requirement for eligible current account derivative transactions exceeding $2 million where foreign currency is purchased against the rupee. It subsequently extended the requirement to certain banks' own hedging contracts without a minimum transaction threshold. This is expected to affect liquidity alongside the RBI’s decision to increase the daily cash reserve balance requirement from 90% to 99% of the prescribed cash reserve ratio requirement. According to ICICI Bank, the two measures would sterilise around 0.4-0.6% of net demand and time liabilities (NDTL). The report also said the measures had pushed bond yields higher.5. Opening a special dollar window for oil companies: The RBI has opened a special dollar window for public sector oil marketing companies. This allows them to meet their dollar requirements through the facility, taking their demand out of the regular foreign exchange market in the immediate term. Together, the measures are intended to ease pressure on dollar demand. However, ICICI Bank has cautioned that sustained currency stability will depend on broader external conditions, particularly capital flows and crude oil prices.Stronger buffer, but how much can the RBI spend?Foreign exchange reserves give the RBI a cushion to manage sharp falls in rupee. When the central bank sells dollars in the market, banks pay for them in rupees. This adds to the supply of dollars and can help ease pressure on the currency.India’s foreign exchange reserves hit a record $785.71 billion in the week ended September 4, 2026, after rising by a record $44.9 billion in a single week. However, RBI data showed that reserves had fallen to around $726 billion as of October 9, 2026.So, how much can the RBI afford to spend to support the rupee? There is no fixed limit, said Jyoti Prakash Gadia, managing director of Resurgent India Limited. The key is whether the reserves are enough to meet the country’s needs.“The RBI does not have any fixed specific amount of money that it can spend in defending the value of the Indian rupee. The issue lies in how much reserves will be sufficient in comparison to the volume of India’s total annual imports, repayment obligations of its external debt, possible future outflows of capital and other forward obligations. According to the data of the RBI, as of October 9, 2026, the level of reserves is close to $726 billion,” the expert told TOI.However, he added that the headline reserve figure alone does not show how much the RBI can comfortably spend. The bigger concern is whether the central bank is using up reserves without restoring market confidence.A stronger rupee alongside falling reserves can be a warning sign, too. “An appreciation of the rupee along with decreasing foreign reserves suggests that intervention is acting as a buffer to external pressures instead of an improvement in the dollar situation,” Gadia said.Selling dollars can help limit the short-term rise in the cost of imports and ease inflationary pressure. But if the RBI has to keep using its reserves to support the rupee without improving market confidence, the strategy becomes harder to sustain.Gadia also cautioned that a weekly fall in reserves does not necessarily mean the RBI has sold dollars, as changes in valuation can also affect the total.To assess how comfortably India can manage external pressure, it is therefore important to look beyond the headline reserve figure. Import cover, external debt repayments, capital flows, forward contracts and the reserves actually available for use all matter.The cost of intervention: Costlier hedging and tighter liquidityThe RBI’s curbs have unsettled parts of the currency market where businesses hedge exchange-rate risks and banks manage their exposures.According to anonymous bankers cited by Reuters, rupee forward premiums rose to multi-year highs earlier this week after the latest foreign exchange curbs tightened liquidity and made it harder for traders to manage exposures.The one-year implied hedging cost rose by more than 90 basis points during the week to 4.6%, its highest level since January 2022. This was well above the roughly 2% implied by the India-US interest-rate differential.The strain was sharper for shorter tenors. The three-month implied hedging cost rose to 7.2%, against a theoretical 1.5%. Overnight swap costs climbed to around two paise, more than four times their usual levels, partly driven by the RBI’s sell/buy swaps.The report also noted that the gap between onshore and non-deliverable forward rupee rates had widened. The one-month deliverable dollar-rupee forward premium was last quoted at around 60 paise, compared with 50 paise offshore. Bankers said bid-ask spreads on one-year forward premiums had widened significantly.These figures reflect the strain reported by market participants. Hedging helps businesses manage uncertainty over future currency payments, but a rise in hedging costs makes protection against rupee depreciation more expensive.Intervention also affects liquidity in the banking system. Gadia explained that when the RBI sells dollars in the spot market, banks use rupees to buy them, reducing their balances with the central bank and draining liquidity.The impact depends on the amount of liquidity already available.In Gadia’s words, “In a tight liquidity system, persistent offloading could cause the overnight rates to rise due to increased costs of borrowing and perhaps even lead to the rates of borrowing and bonds increasing. On the other hand, in a liquidity surplus system, the offload could just end up removing the excess liquidity.”The RBI can offset the drain through repurchase transactions or by purchasing government bonds to replenish cash in the market, he added.The trade-off is that efforts to ease currency pressure can affect liquidity, borrowing costs and the price businesses pay to manage foreign exchange exposure.At the same time, a weaker rupee does not affect every group in the same way. Intervention to support the currency also creates winners and losers.According to Gadia, importers benefit when RBI dollar sales help the rupee appreciate to a level stronger than it would otherwise have reached. Companies with unhedged dollar liabilities can also gain, while consumers may benefit indirectly if imported inflation eases. However, the impact on consumer prices is neither immediate nor complete.Exporters and people receiving remittances from abroad, on the other hand, get fewer rupees for their dollars than they would have received if the rupee had depreciated further. Cheaper imported inputs can partly offset this disadvantage for exporters. Investors leaving India may also receive additional dollars in return for their rupees when the currency is stronger than it would otherwise have been.If not RBI, who rescues rupee?If the RBI reduces intervention, Gadia said, rupee is likely to depreciate further until demand and supply move towards equilibrium. That could raise import costs, inflation and the cost of servicing unhedged foreign exchange debt, while making exports more competitive.However, depreciation alone does not guarantee an export boost. The benefit depends on demand in foreign markets, manufacturing capabilities and the cost of imported raw materials.“If RBI intervention is reduced, the Indian rupee is likely to depreciate further until supply and demand for the rupee come to an equilibrium. This could result in increased cost of imports, inflation, and unhedged foreign exchange debts while making exports more competitive. The extent to which exports benefit from rupee depreciation depends on foreign market demand, manufacturing capabilities, and the cost of imported raw materials.”Gadia also identified several possible strategies: intervention aimed at correcting disorderly markets, inflation management, policies that encourage long-term capital inflows and improved corporate hedging. Raising interest rates may be useful when justified by inflation considerations, but it would also slow economic growth.The debate has drawn differing views from policymakers and economists.The International Monetary Fund said India should allow the exchange rate to move as the first line of defence. Economists, meanwhile, have warned that exchange rates can overshoot during global disruptions and should not automatically be treated as stabilisers.Michael Debabrata Patra, former deputy governor of the Reserve Bank of India (RBI) told Reuters that effective communication could help cushion the impact of global disruptions.“What could possibly help in promoting orderly market activity and bolstering market confidence is perhaps timely and patient communication to shape expectations,” he told Reuters.The supplied report also noted that the RBI’s monetary policy committee had raised the benchmark repo rate by 25 basis points at its most recent meeting and changed its stance from “neutral” to “calibrated tightening”.The minutes reflected caution about tightening too quickly and inhibiting economic growth.Possible strategies include intervention aimed at correcting disorderly markets, inflation management, policies that promote long-term capital inflows, and improved corporate hedging. Raising interest rates might be useful where such a strategy is warranted by inflation considerations but will slow economic growth.The bottom lineA stronger rupee alongside falling foreign exchange reserves may suggest that the RBI is cushioning the currency against external pressures rather than easing those pressures. While selling dollars can help limit the rise in import costs in the short term, repeatedly using reserves to support rupee can become a concern if market confidence does not improve. Gadia also cautioned that weekly declines in reserves may partly reflect changes in valuation.The RBI’s challenge, therefore, is not simply to push rupee higher. It is to curb sharp fluctuations while keeping enough reserves to meet India’s import needs, repay external debt and deal with possible future capital outflows.The recent recovery shows that measures to curb dollar demand can help ease pressure on the currency. But higher hedging costs, liquidity concerns and the risk of further external shocks show that intervention comes with its own costs. As ICICI Bank noted, lasting stability will also depend on capital flows and crude oil prices.Ultimately, the RBI must weigh how much intervention can achieve against what it costs. The aim is not to defend a particular number on the exchange-rate screen at any price, but to keep the market orderly without leaving the economy with a thinner safety net.You use AI every day. Now get your AI Quotient. Take the AIQ test.