RBI Hikes Rate, Vows to Stabilize 'Undervalued' Rupee; Liquidity Measures Draw Focus

The Reserve Bank of India raised the policy rate by 25 basis points Wednesday, its first such tightening since February 2023, and pledged to support the rupee after the currency slipped to a five-month low of 96.8450 per dollar. The central bank also raised its inflation and growth projections for the current fiscal year.

Governor Sanjay Malhotra said the rupee is "undervalued" in real effective exchange rate terms and that short-term market moves can be irrational. "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, responding to the rupee's intra-day decline.

The rupee closed at 96.7750, down 0.4% from the previous close of 96.42. It remains close to its all-time low of 96.96 to a dollar, hit on May 20, and has lost 7% so far in 2026.

While higher interest rates typically attract foreign capital and strengthen a currency, persistent outflows from Indian equity and debt markets have kept the rupee under pressure. Bank of Baroda chief economist Madan Sabnavis attributed the pressure to "a factor of stronger dollar index and withdrawal of debt and equity investments by foreign investors."

Traders said the RBI intervened in the foreign exchange market to limit the fall. The central bank likely conducted dollar-rupee sell-buy swaps to absorb surplus liquidity, pushing the one-year forward premium to 3.82%, its highest in six months. The three-month forward premium rose to 4.95% and the six-month premium to 4.4%.

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

**Liquidity and the FCNR(B) Facility**

Wednesday's rate decision and rupee commentary come as the RBI continues to manage liquidity. The central bank closed a special facility for Foreign Currency Non-Resident (Bank) deposits on August 31. The scheme, launched on June 8, 2026, allowed banks to offer higher interest rates on FCNR(B) deposits by transferring the currency hedging cost to the RBI.

As of the closure date, banks had mobilized $133 billion through the scheme, according to the governor. Analysis estimated the annual hedging cost to the RBI at around 2.8–3.0%, raising questions about the net benefit.

Malhotra defended the scheme, saying the cost to the central bank should be evaluated alongside the wider economic gains. "The cost to the RBI should be assessed alongside the wider benefits generated by the scheme," he said at the post-monetary policy press conference. He described the recent pressure on the current account and moderation in external flows as temporary and expressed confidence that the external sector would improve "sooner than later."

The swap carried a fixed rate of 1.5% per annum, compounded semi-annually. Banks sold dollars to the RBI at the FBIL Reference Rate and agreed to repurchase the same amount at maturity.

While the window for FCNR(B) deposits has closed, a similar facility for Overseas Foreign Currency Borrowings and External Commercial Borrowings will remain available until December 31, 2026. Malhotra said the repayment risks linked to FCNR(B) deposits remained manageable, citing strong macroeconomic fundamentals and "adequate" foreign exchange reserves as buffers.

**Market and Investor Implications**

For emerging-market investors, the RBI's dual focus on rate tightening and currency stability signals a continued effort to manage the rupee without resorting to sharp devaluation. The rate hike, combined with the central bank's intervention in the forward market, is aimed at mopping up excess rupee liquidity while limiting one-way bets on the currency.

The rise in forward premiums suggests hedging costs are increasing, a factor that could dampen speculative positioning. With foreign portfolio investors still pulling funds from Indian markets, the RBI's ability to defend the rupee will remain a key test for policymakers in the months ahead.