Reasons Behind Rupee's Weakness Against the Dollar
Context:
The Reserve Bank of India (RBI) recently intervened in the market by selling large amounts of US dollars to arrest the rupee's decline.
Despite this, the rupee has lost almost 6% of its value over the past year.
The Rupee Puzzle:
The rupee is weakening even though India is the fastest-growing major economy with well-contained inflation and stable external sector metrics (like trade deficit and external debt).
Previously, the rupee's fall was attributed to a strengthening dollar.
However, in recent months, the rupee has continued to weaken even when the dollar itself is weakening against other global currencies.
Key Drivers:
A study by Bank of Baroda (BoB) analyzing daily data from October 2020 to November 2025 identified three primary factors explaining the exchange rate:
RBI's Spot Intervention: The central bank's buying/selling in the spot market.
RBI's Forward Positions: Changes in RBI's forward contracts (agreements to buy/sell currency in the future).
Foreign Portfolio Inflows (FPI): The flow of foreign investment into Indian markets.
Role of Forwards and FPIs:
The study found that the RBI's activity in the forward market plays a more significant role than spot intervention, likely due to the strong messaging involved in such moves.
Surprisingly, the trade deficit was found to have no significant bearing on the rupee's fluctuations.
This may be because recorded trade data doesn't always reflect immediate dollar flows (for example, exporters holding earnings overseas).
The study concludes that in the immediate run, Foreign Portfolio Investors (FPIs) play a major role, and factors beyond economics account for a significant portion of the currency's variation.