RBI Should Rethink Forex Strategy: Economists

Economists said that the Reserve Bank of India (RBI) should come up with a revamped foreign exchange strategy in 2025, while also suggesting loosening its grip on the rupee. The currency remains strongest among its peers in terms of trade-weighted terms in the last two decades.

As per Reserve Bank of India's latest bulletin, rupee’s 40-currency trade-weighted real effective exchange rate (REER) clocked at 108.14 in November, an overvaluation of currency by 8%.

Indian exports are turning out to be more expensive due to rupee’s overvaluation. This is the most overvalued the rupee has been since 2004, RBI data reported.

Notably, the central bank has regularly intervened in the forex market to maintain fluctuations in the rupee. In fact, the Indian rupee has been the least volatile Asian currency after the Hong Kong dollar.

However, the situation could change in 2025.

Gaura Sen Gupta, India economist at IDFC FIRST Bank said, “Given the rise in rupee's overvaluation...the pace of RBI forex intervention will need to slow.”

Rupee’s 30-day daily realised volatility touched six-month high and it is expected to report its biggest monthly decline in two years. During December the currency dropped by 1.2% respectively.

What are the threats for the rupee?

Rising US bond yields and India’s decline in growth, unoptimistic rate cut measures by the US Federal Reserve and concerns over Donald Trump’s trade policies are likely to challenge Indian rupee.

Dhiraj Nim, an economist and FX rates strategist at ANZ said “It is after several years that both 'pull' (growth slowdown) and 'push' factors (external headwinds) for portfolio flows are not in favour of the rupee.”

He added, “So, an adjustment is warranted.”

Appointment of new governor

The appointment of Sanjay Malhotra as the RBI's new governor is fuelling the hopes for a structured rupee management system.

Nomura said, “The RBI governor plays an important role in driving the central bank's currency management strategy.”

“It is possible that a bit more flexibility is allowed in currency fluctuations, going forward, as compared to the relatively tighter leash seen over the last one year and more.”