RBI Hikes Rate 25 Bps, Vows to Correct ‘Undervalued’ Rupee as Currency Hits Five-Month Low

The Reserve Bank of India raised its policy rate by 25 basis points Wednesday, the first tightening since February 2023, and Governor Sanjay Malhotra said the central bank would ensure that the “undervalued” rupee finds its correct level after the currency sank to a five-month low.

The rupee touched 96.8450 per dollar during the session, not far from its all-time low of 96.96 hit on May 20, according to data from the Reserve Bank of India. The currency has lost 7% so far this year. It closed at 96.7750, down 0.4% from the previous close of 96.42.

“We will ensure the rupee stabilises and finds its correct value. We will support the rupee’s orderly movement,” Malhotra said at the post-policy media interaction, according to a report by Indiatimes. He described the rupee as undervalued in terms of the real effective exchange rate and noted that markets could be “irrational in the short run.”

While higher interest rates typically support a currency by offering better returns to overseas investors, persistent foreign capital outflows from Indian markets kept the rupee under pressure. “It’s likely to be a factor of stronger dollar index and withdrawal of debt and equity investments by foreign investors,” Bank of Baroda chief economist Madan Sabnavis told Indiatimes.

**Intervention in Forwards**

Traders said the RBI intervened in the forex market to cap the fall. The central bank likely conducted dollar-rupee sell-buy swaps to absorb surplus liquidity from the inter-bank market, pushing the one-year forward premium to 3.82%, its highest in six months, Indiatimes reported citing market participants. The three-month forward premium rose to 4.95% while the six-month premium climbed to 4.4%.

“Corporates were seen buying forward in panic,” forex market consultant KN Dey told Indiatimes. “It’s also rare for the rupee to sharply weaken on a day when the RBI tightens policy rate,” he added.

The RBI also raised its inflation and growth projections for fiscal year 2027, according to the Indiatimes report on the policy.

**FCNR(B) Deposit Scheme Defense**

Separately, Malhotra defended the rationale behind the special foreign-currency deposit facility that was closed at the end of August, saying the broader economic benefits outweighed the hedging costs incurred by the central bank. The special USD-INR forex swap facility for Foreign Currency Non-Resident (Bank) deposits—introduced on June 8, 2026—allowed banks to offer higher interest rates by transferring the currency hedging cost to the RBI.

As of the August 31 closure, banks had mobilized USD 133 billion through the scheme, Indiatimes reported. Analysts had estimated the RBI’s annual hedging cost at around 2.8-3.0%, but Malhotra said the cost should be assessed against the wider benefits for the economy.

“The RBI’s primary consideration was the overall benefit to the economy rather than the hedging expense involved,” he said at the post-policy press conference. Under the arrangement, participating banks sold dollars to the RBI and agreed to repurchase them at the end of the swap period at a fixed rate of 1.5% per annum, compounded semi-annually.

The facility for External Commercial Borrowings and Overseas Foreign Currency Borrowings remains open until December 31, 2026, Indiatimes reported.

Malhotra described repayment risks linked to FCNR(B) deposits as manageable, citing strong macroeconomic fundamentals and adequate foreign exchange reserves. He characterized the recent pressure on the current account and the moderation in external flows as temporary, adding he expected the external sector to improve sooner rather than later.

**Market Context**

The rate hike and rupee commentary come as traders had anticipated not only a tightening but also additional liquidity-draining measures, according to a Bloomberg summary of the market outlook. The RBI’s forward-market intervention and its stated commitment to rupee stability are likely to remain in focus as foreign portfolio outflows continue to weigh on the currency.