The rupee has reached 100 per dollar for one-year delivery, while the spot currency fell to 96.7750 on Wednesday despite the RBI’s 25-basis-point rate increase. Governor Sanjay Malhotra’s suggestion that the rupee may be undervalued sits uneasily alongside this persistent weakness. The gap is not necessarily between a rational central bank and an irrational market, but between an assessment of value and the immediate need for dollars.

The forward milestone needs to be read correctly. It is a contracted exchange rate for future delivery, not a forecast that the spot rupee will reach 100 in a year. Interest-rate differentials and conditions in the forward market influence that price. Higher Indian rates can themselves increase the premium on future dollars even while supporting the spot currency.

Wednesday’s spot trading nevertheless exposed the limits of the policy’s immediate support. The rupee weakened by 35.5 paise from Tuesday’s close, recovering only modestly from its intraday low as suspected RBI intervention emerged. A rate increase and a shift to calibrated tightening were insufficient to reverse the pressure.

Rational Hedging
Malhotra’s observation that markets can behave irrationally in the short run does not settle the question of what is driving the currency. An importer protecting a dollar payment against further depreciation need not be expressing a view on India’s long-term prospects. It is managing a liability with a deadline.

Exporters face the opposite incentive. Expectations of further depreciation encourage them to postpone conversion of dollar receipts, while importers bring purchases and hedging forward. When both happen together, dollar demand strengthens precisely when supply becomes less forthcoming. Individually defensible decisions can therefore reinforce a currency decline without requiring either side to misunderstand economic fundamentals.

This pressure also has an external foundation. Brent crude above $100 sustains import-related dollar demand, while a US 10-year yield above 5.3% raises the hurdle for attracting capital into rupee assets. Continued foreign portfolio outflows compound the imbalance. Strong domestic growth does not automatically supply the dollars required to meet these external demands.

The rate hike offers some support through the interest-rate differential and inflation expectations. But a move already anticipated by the market cannot be expected to overwhelm oil payments, capital withdrawals and defensive hedging. Its inability to lift the rupee immediately is not proof that monetary tightening has failed.

Orderly Adjustment
The more difficult issue is what the market understands by orderly depreciation. The RBI is right to curb excessive volatility rather than defend a particular exchange rate. But smoothing the adjustment must not be confused with endorsing a predictable path towards a weaker currency.

A market convinced that depreciation will be gradual but persistent has little reason to change its hedging behaviour. Intervention may then contain the size of daily moves without weakening the conviction behind them. Reassurance about undervaluation is unlikely to be enough while the underlying dollar imbalance persists.

Nor should monetary policy be judged by whether it prevents the spot rupee from crossing 97. Malhotra’s emphasis on data-dependent action is not a promise to tighten enough to deliver immediate appreciation. Interest-rate policy must address inflation rather than become hostage to a currency threshold.

The durable answer remains more reliable foreign-exchange earnings and investment inflows. Until those improve, the RBI can manage the adjustment but cannot substitute indefinitely for missing dollar supply. The rupee can be undervalued and still weaken; policy must address the financing imbalance, not merely question the market’s judgement.