Rupee nears record low despite RBI raising repo rate to 5.50%

The Indian rupee slid close to its historic low against the US dollar on Wednesday, even after the Reserve Bank of India delivered its first interest rate hike in nearly four years.

The central bank raised its benchmark repo rate by 25 basis points to 5.50% and shifted its policy stance to "calibrated tightening". But the hawkish move failed to immediately shore up the currency. The rupee dropped to 96.8450 per dollar, hovering just above the record low of 96.96 it hit in May.

Sanjay Malhotra defends the rupee

Addressing the currency's weakness, RBI Governor Sanjay Malhotra urged patience and suggested the market was mispricing the rupee.

"Financial markets can be irrational in the short run," Malhotra told a press conference after the policy announcement. "It is only in the long run they are able to find the right value."

Malhotra argued that by several metrics, including the real effective exchange rate (REER), the rupee is likely undervalued. He promised that the central bank would step in to ensure orderly movement and prevent "excessive volatility" in forex markets.

Why the RBI hiked rates

The rate hike follows a sharp rise in domestic inflation. India's consumer price index rose to 4.8% in August and is projected to climb to 6% in the third quarter, putting it at the absolute ceiling of the RBI's tolerance band.

At the same time, strong domestic growth — projected at 7.1% — has given the monetary policy committee the economic headroom to raise borrowing costs without risking a slowdown.

Sumit Singhania, head of research at Bajaj Broking, said the central bank's decision was highly defensible given the economic data. "With CPI rising... acting now makes sense," Singhania said, noting that the global economic environment has left the RBI with little room to remain accommodative.

The pressure from the US Federal Reserve

The RBI is also reacting to an aggressive posture from the US Federal Reserve, which raised interest rates in September. With markets pricing in another US hike by December, and the October 28 Federal Open Market Committee meeting looming as a live risk, the pressure on emerging market currencies like the rupee is intense.

Analysts believe the RBI's shift to "calibrated tightening" is a crucial shield. Radhika Rao, senior economist and executive director at DBS Bank, said the combination of higher local inflation forecasts and a tighter policy bias should keep short-term Indian rates elevated.

This shift, Rao added, is "modestly constructive" for the rupee. Wider interest rate differentials between India and the US, combined with a clear tightening bias, should make the rupee more resilient to external shocks, even as a strong US dollar continues to dominate global trade.