In a significant market movement in early December 2025, the Indian rupee breached the psychological mark of 90 against the US dollar for the first time. This depreciation, amounting to roughly 6% over the course of the year, was driven by foreign investors pulling money out of Indian stocks and concerns over US tariffs impacting export competitiveness.
The Official Stance: No Sleep Lost Over Slide
On December 5, Reserve Bank of India Governor Sanjay Malhotra set a clear tone, stating that the central bank does not target specific price levels or bands for the rupee, allowing markets to determine its value. Echoing this calm approach, Chief Economic Adviser V. Anantha Nageswaran told reporters the government was not "losing sleep" over the decline.
He emphasized that the currency's fall was not adversely affecting inflation or exports and expressed confidence that the situation would improve in 2026. These statements were not mere reassurances but reflected a deep-seated economic principle guiding India's policy framework.
The Governing Framework: The Impossible Trilemma
The rupee's trajectory is dictated by a fundamental constraint in international economics known as the "Impossible Trilemma," formulated by economists Robert Mundell and Marcus Fleming. It posits that a country cannot simultaneously maintain all three of the following: free capital movement across borders, an independent monetary policy, and a fixed exchange rate. A nation must choose two.
As Nobel laureate Paul Krugman succinctly put it, "you can't have it all." India's choice, solidified since the economic liberalization of the 1990s, has been to prioritize monetary policy independence and open capital accounts, accepting a flexible exchange rate as the necessary trade-off.
Ranen Banerjee of PwC India explains, "In the case of India, we have made a choice of having independence in setting interest rates and having free capital mobility. Thus, we will not have the ability to control exchange rates and it has to be floating."
Inflation Control: The Non-Negotiable Priority
This choice is institutionalized through India's flexible inflation-targeting framework, adopted in 2016, which mandates the RBI to keep Consumer Price Index (CPI) inflation at 4% within a tolerance band of 2-6%. In 2025, with inflation falling remarkably low—even below the 2% lower band for three consecutive months—the RBI's focus remained unwavering.
The central bank's earlier rate hikes between May 2022 and February 2023, which raised the repo rate by 250 basis points to combat post-pandemic inflation, exemplify this commitment. These actions, while potentially influencing capital flows, were taken to ensure domestic price stability, demonstrating that controlling inflation takes precedence over managing the exchange rate.
Why a Flexible Rupee is a Strategic Tool
Allowing the rupee to adjust, rather than depleting reserves to defend an arbitrary level, serves multiple strategic purposes:
Preserving Forex Reserves: India's foreign exchange reserves, standing at around $686.8 billion in early January 2025, are a crucial buffer. Aggressively defending a specific rupee level could rapidly drain these reserves, leaving the economy vulnerable during a true crisis.
Boosting Export Competitiveness: A weaker rupee makes Indian exports cheaper in dollar terms, which can help offset some disadvantages posed by external factors like US tariffs.
Deterring Speculation: When the rupee is allowed to move both ways—appreciate and depreciate—it increases risk for currency speculators, making one-way bets less attractive.
Sachchidanand Shukla, Group Chief Economist at L&T, notes, "An aggressive defense of the INR at the current juncture could be futile. Instead, two-way movement in INR can be used to absorb some of the global pressures, preserve FX buffers and allow market-driven adjustments."
Historical Lessons: When Countries Tried to 'Have It All'
History offers stark warnings of what happens when nations ignore the trilemma:
- 1992 UK (Black Wednesday): Attempting to maintain a peg within the European Exchange Rate Mechanism while capital flowed freely led to a massive speculative attack. The UK was forced to devalue the pound and exit the mechanism.
- 1997 Asian Financial Crisis: Nations like Thailand tried to maintain currency pegs with open capital accounts despite economic imbalances. The eventual collapse led to severe currency devaluations and economic turmoil.
- 2001 Argentina: Clinging to a dollar peg led to a catastrophic economic collapse, a sovereign default, and a dramatic fall in the peso's value.
These episodes underscore that trying to defy the trilemma's constraints often results in a more severe and disruptive adjustment later.
The Road Ahead for the Rupee
The future path of the rupee will be influenced by a mix of external and domestic factors, including US Federal Reserve policy, global oil prices, India's growth and FDI inflows, and domestic inflation trends. The underlying policy framework, however, is set. The RBI will continue to intervene only to curb excessive volatility, not to steer the currency to a predetermined level.
The depreciation of the rupee in 2025 is not a sign of policy failure but the outcome of a deliberate and strategic choice. By accepting exchange rate flexibility, India safeguards its ability to set interest rates for its own economic needs and maintains access to global capital—a trade-off that defines modern monetary management in an interconnected world.
