Significant Dollar Inflows Offer Limited Support for Rupee: Outlook for Currency Near Rs 96 in the Short Term
After experiencing significant fluctuations throughout the year, the Indian rupee is projected to stabilize against the US dollar. A recent report from Bank of Baroda indicates that the currency is likely to trade within the range of Rs 94.5 to Rs 96 per dollar in the near term. This stability comes despite substantial dollar inflows from Foreign Currency Non-Resident (FCNR) deposits and external commercial borrowings (ECBs).
The report highlights that these inflows have primarily contributed to the Reserve Bank of India’s reserves rather than entering the market. Consequently, this limited the potential appreciation of the rupee that could have resulted from increased dollar supply. The report states, “In the current situation a range of Rs 94.5-96 looks likely in the near term.” It further notes that the anticipated sharp appreciation of the rupee has not materialized, as the inflows have not been infused into the market.
Factors Influencing Rupee Movements
The analysis from Bank of Baroda suggests that the exchange rate is influenced by a combination of factors, including fundamentals, Reserve Bank of India (RBI) interventions, and market sentiment. Since January 2022, the rupee has depreciated by approximately 28%, with its average exchange rate shifting from Rs 74.44 per dollar to Rs 95.47 by August 2026. Other Asian currencies have also seen declines, with the Japanese yen falling by 38% and the Indonesian rupiah and South Korean won depreciating by 24% and 17%, respectively.
The report examined monthly currency data from January 2022 to June 2026, focusing on foreign exchange reserves, RBI operations, foreign portfolio investment (FPI) flows, and the dollar-euro exchange rate. It found that RBI interventions have a significant relationship with rupee movements, particularly when considering both spot and forward operations together. Their combined explanatory power was 34%, compared to 25% for spot interventions alone.
Limited Impact of Forex Reserves
While forex reserves showed some influence, their explanatory power was relatively limited at 18%. This suggests that even a significant increase in reserves due to dollar inflows does not necessarily lead to major movements in the exchange rate. The report also noted that while FPI flows initially appeared to have a significant relationship with the rupee, this significance diminished when analyzed alongside other variables.
The findings indicate that the factors driving the exchange rate operate through multiple channels, complicating the identification of a single dominant variable. The analysis revealed that no more than 40% of the variation in the rupee could be explained by the studied variables. A considerable portion of the movement remains unaccounted for, attributed largely to market sentiment, including the timing of dollar purchases by importers and exporters and remittance flows.
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