US interest rates are testing India’s rupee policy: The US Federal Reserve’s interest-rate decisions do not stop at America’s borders. Higher US yields can make dollar assets more attractive, drawing money away from emerging markets, raising their borrowing costs and putting pressure on their currencies. India has faced this pressure before. The question now is how far the Reserve Bank of India should go in resisting it.
The International Monetary Fund’s latest assessment of India argues that the rupee should be given greater freedom to adjust to external shocks. Monetary policy, in its view, should remain focused on domestic price stability. The RBI would still need to intervene in the foreign-exchange market, but intervention should be aimed at preventing disorderly movements rather than defending a particular rupee-dollar level.
READ | Rupee outlook: Why India’s external buffers matter
That distinction is important. A weaker rupee is often taken as a sign that the economy is in trouble. Yet the exchange rate also provides a means of absorbing shocks originating outside India. When US interest rates rise, investors reassess the returns available across markets. If money moves towards dollar assets and demand for dollars increases, the rupee comes under pressure. Some depreciation can absorb that pressure without requiring an equivalent adjustment in domestic interest rates or a large drawdown of foreign-exchange reserves.
The pressure from US rates
A rise in US interest rates increases the return on dollar assets. The effect on emerging markets becomes stronger when investors expect US rates to remain high or rise further. Capital flows can become more selective, currencies can weaken and companies with foreign-currency liabilities can face higher repayment costs.
India experienced this pressure in September. The Federal Reserve raised its target range for the federal funds rate by 25 basis points to 3.75%-4% on September 16. The rupee subsequently moved beyond ₹96 to the dollar before recovering some ground. The currency was also dealing with higher crude oil prices, elevated global bond yields and weak foreign investor appetite.
There is little the RBI can do about the underlying causes of all these pressures. It can smooth the adjustment, however, and it can prevent a bout of speculation or a shortage of liquidity from turning a currency decline into a disorderly market.
The distinction becomes important when reserves are used to resist a sustained change in the exchange rate. India has a large stock of foreign-exchange reserves, but those reserves are a form of insurance against external shocks. They should not become a standing commitment to a particular exchange rate.
The IMF made a similar point in its 2025 Article IV assessment of India. It argued for greater exchange-rate flexibility, given India’s limited foreign-exchange mismatches, relatively deep currency market and adequate reserves. Intervention, it said, should be reserved for periods when markets become disorderly or risk premia rise sharply.
The RBI cannot follow the Fed
Greater exchange-rate flexibility does not mean that the RBI can disregard the rupee. A weaker currency makes imports more expensive, and crude oil is particularly important for India because the country depends heavily on imports to meet its oil requirements. A sharp depreciation can therefore feed into domestic inflation.
That does not mean Indian interest rates should move in step with those in the United States. The two economies face different inflation, growth and credit conditions. If the RBI raises rates whenever the Federal Reserve does, it risks tightening financial conditions in India for reasons that may have little to do with the domestic economy.
READ | Rupee depreciation tests India’s record forex reserves
The RBI’s inflation-targeting framework places domestic inflation at the centre of monetary policy. The exchange rate enters that calculation because it affects import prices and inflation expectations. It cannot, however, become the overriding consideration each time the dollar strengthens.
The cost of defending the rupee also has to be considered. An aggressive response to every period of currency weakness can require large interventions in the foreign-exchange market. If that is combined with higher domestic interest rates, the burden of adjustment shifts from the currency to borrowers, consumers and businesses.
There is also a lesson for companies that borrow in foreign currency. A company that assumes the RBI will prevent significant rupee movements has less reason to protect itself against exchange-rate risk. A currency that is allowed to move in both directions gives borrowers a stronger incentive to hedge their exposure.
The IMF has made this point as well. Its 2025 assessment noted that greater exchange-rate flexibility could encourage private-sector entities to manage currency risks through hedging. It also reported that around two-thirds of external commercial borrowings were hedged as of September 2024.
READ | Rupee trade gets easier, but the hard part remains
What reserves should be used for
India is better equipped to deal with external financial shocks than it was in earlier periods of vulnerability. The banking system is stronger, foreign-exchange markets are deeper and the country has accumulated a substantial reserve cushion.
But reserves are not cost-free. Foreign-exchange data from September illustrate the point. Reserves stood at $765.9 billion in the week ended September 18, 2026, and fell to about $747.6 billion in the following week. A decline of that size does not by itself indicate a crisis. It does show, however, that resisting pressure on the rupee can involve a significant use of the country’s external buffer.
The RBI therefore needs to distinguish between a market that is moving and a market that is becoming disorderly. A currency can fall because economic conditions have changed. That is part of how an exchange rate works. Intervention becomes more defensible when trading conditions themselves become dysfunctional or when a sudden move threatens financial stability.
This does not call for a hands-off policy. The RBI has good reason to intervene when necessary. It has to ensure that the foreign-exchange market continues to function and that temporary bouts of stress do not become self-reinforcing. But that is different from trying to establish where the rupee should trade against the dollar.
For India, the more durable approach is to let the exchange rate absorb a reasonable share of external shocks while using reserves when they are genuinely needed. Monetary policy should respond to India’s own inflation and growth conditions.
The rupee may look more stable when the RBI leans heavily against every bout of depreciation. That appearance can be misleading. If maintaining the exchange rate requires excessive intervention or interest rates that are out of line with domestic conditions, the cost is merely being borne elsewhere in the economy.
India has enough reserves and a sufficiently developed financial system to allow the rupee greater flexibility. The RBI’s task is to use those strengths to manage volatility rather than to promise a particular value for the currency.