RUPEE STABILITY FOR NOW BUT STRAINS AHEAD

RUPEE STABILITY FOR NOW BUT STRAINS AHEAD Shumita Deveshwar

◼ RBI intervention to support undervalued rupee imply relative stability in short-term ◼ Oil price risk looms but overseas bank deposits and debt flows provide some cushion ◼ Structural weaknesses persist amid foreign equity outflows and tepid net FDI inflows The rupee’s fall in July once again brought its severe undervaluation in focus, with the Reserve Bank (RBI) actively intervening in the FX markets in recent days to support the currency. As Chart 1 below shows, the rupee has been falling in real effective terms (REER) since early ’25, and its current phase of undervaluation has been the longest in over a decade (see Chart 2). As recently as Nov ’24, the rupee touched record levels of overvaluation, but has since been beaten down on several counts – from the US trade deal uncertainty to persistent foreign outflows and surging oil prices; the rupee last week fell close to the May ’26 record low of just under 97/US$. Governor Sanjay Malhotra, in a local newspaper interview this week, also noted that the currency is undervalued in both real and nominal terms. His comments and recent RBI action imply that further depreciation is likely to be limited, especially if oil prices stabilise.

Chart 1: Real effective rate vs exchange rate Chart 2: Real effective rate since 2006

REER (40 currency basket) - LHS USD/INR - RHS

96 REER below 100 = undervaluation 90 92

92 94 88 REER below 100 = undervaluation 88 98 84

Jan-22 Jul-22 Jan-23 Jul-23 Jan-24 Jul-24 Jan-25 Jul-25 Jan-26 Jun-06 Jun-08 Jun-10 Jun-12 Jun-14 Jun-16 Jun-18 Jun-20 Jun-22 Jun-24 Jun-26

Sources: RBI, Bloomberg. Source: RBI.

India is highly vulnerable to global price movements as it imports >85% of its annual crude requirements (see our 9 March 2026 report Iran war strikes where it hurts most: oil for an in- depth look at how India’s macro is at risk). Last week’s sharp depreciation of the rupee came as tensions flared up again between Iran and the US. The RBI in April had assumed Brent crude to average US$85/bbl and the rupee to average 94/US$ in FY27; so far in the fiscal year, oil has

averaged US$92.5/bbl and the rupee 94.9/US$. In his newspaper interview, Governor Malhotra reiterated the RBI’s stance that it doesn’t target a specific level for the rupee but intervenes “whenever necessary… to curb excessive volatility”. The continuing geopolitical uncertainty means the rupee will remain volatile, prompting continued RBI action.

Chart 3: Rupee vs price of India’s oil import basket

USD/INR - LHS India crude import basket (US$/bbl) - RHS 74 120

Jan-22 Jul-22 Jan-23 Jul-23 Jan-24 Jul-24 Jan-25 Jul-25 Jan-26 Jul-26

Sources: Petroleum Planning & Analysis Cell, Bloomberg.

The RBI has actively intervened in the FX market since the start of the Iran war, and in June it announced other policy measures to attract inflows, including incentives for banks to mobilise foreign currency deposits from non-resident Indians (FCNR(B) deposits) and for companies to tap overseas borrowings. Around US$40bn have flowed in since, mostly into the FCNR(B) deposits. As a result, even though the RBI has been drawing down on its hefty war chest of FX reserves, there was a recent uptick in the reserves thanks to the inflows, as Chart 4 below illustrates. RBI’s Malhotra expects FCNR(B) inflows to exceed US$50bn before the deposits window closes on 30 Sep ’26; the amount has already matched the levels of 2013, when a similar scheme was introduced, and the pace of inflows typically strengthens in the final weeks of the scheme. The RBI in June also exempted foreign investors in government bonds from taxes, and increased

Chart 4: Foreign exchange reserves vs RBI’s monthly FX market intervention

RBI's FX reserves (US$ bn) - LHS RBI's net purchases (US$ bn) - RHS

Jan-22 Apr-22 Jul-22 Oct-22 Jan-23 Apr-23 Jul-23 Oct-23 Jan-24 Apr-24 Jul-24 Oct-24 Jan-25 Apr-25 Jul-25 Oct-25 Jan-26 Apr-26 Jul-26