India considers all options to address rupee’s plunge, including rate hikes.

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The Reserve Bank of India (RBI) is facing severe pressure from the rapid depreciation of the rupee and has put a series of unconventional measures such as interest rate hikes and overseas financing on the table. This has triggered intense market attention on a potential shift in India’s monetary policy.

According to Bloomberg, RBI Governor Sanjay Malhotra and other senior officials have recently held frequent internal meetings to discuss coping strategies. This week, the rupee fell to a historic low of nearly 97 to 1 US dollar, becoming the direct trigger for this round of emergency negotiations. One option is to take action before the monetary policy meeting on June 5, and an early rate hike is not ruled out; RBI previously made a similar unusual policy adjustment in May 2022.

Following the news, the market reacted visibly: the rupee rose 0.5% to 96.38 on Thursday, and the 10-year government bond yield fell 3 basis points to 7.05%. Earlier, it had dropped 6 basis points after RBI announced liquidity injection, with gains narrowing thereafter.

Depreciation speed exceeds expectations, policy makers adopt tougher stance

According to people familiar with RBI’s decision-making, there is growing consensus within the policy making circles: The speed of rupee depreciation has already surpassed expectations. Officials believe India’s economic fundamentals remain strong and the banking system is functioning normally, but these strong fundamentals are not being reflected in the exchange rate.

One insider said bluntly: "The central bank’s top priority now is to curb the depreciation, and the RBI is ready to do everything necessary to achieve this goal."

Since the beginning of this year, foreign selling of Indian assets has continued to intensify.

Foreign funds’ net outflows from India’s stock market have exceeded last year’s record level of $19 billion. Meanwhile, the US-India interest rate spread has narrowed to a ten-year low, weakening the appeal of Indian bonds to foreign investors. If an interest rate hike is implemented, it will help re-expand the spread and attract foreign capital back to India’s bond market.

Interest rate hike and overseas financing considered in parallel

Bloomberg citing insiders said the measures under consideration by the RBI mainly cover three directions.

The first is an interest rate hike. RBI’s monetary policy committee is scheduled to meet from June 3-5, with the benchmark rate currently unchanged at 5.25%. Most economists expect an interest rate hike in the coming months as inflation accelerates, and the current pressure on the exchange rate may speed up this process.

The second is launching deposit plans for non-resident Indians (NRI), attracting foreign currency inflows via domestic banks. One source revealed that the RBI estimates such deposit plans could raise up to $50 billion this round, higher than the $30 billion raised during the “taper tantrum” period in 2013.

The third is issuing sovereign US dollar bonds, but this plan requires a final government decision.

Liquidity injection marks the first step, more measures may follow

Before larger-scale policies are implemented, the RBI announced a $5 billion currency swap auction on Wednesday, aiming to inject liquidity into the banking system and replenish foreign exchange reserves in the short term. Insiders reveal that similar swap auction operations could be launched in future.

The logic behind this round of measures closely resembles India’s response framework during the “taper tantrum” in 2013. At that time, India likewise used domestic banks to offer deposit plans for non-residents to stimulate foreign currency inflows. The scale of the policy toolkit this time is bigger, showing the authorities’ determination to stabilize the exchange rate.

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