Exchange Rate Management in India

India's exchange rate is the price of the rupee in terms of other currencies, for example how many rupees one US dollar costs. In India, this price is mostly set by the market, through the demand for and supply of dollars. But the RBI steps in when the rupee moves too sharply. This mix of market freedom and central bank action is called a managed float.

Why does the exchange rate matter?

The rupee's value touches daily life. If the rupee weakens, imported petrol, cooking oil, electronics and foreign education become costlier. This can push up inflation. A weak rupee helps exporters, because their dollar earnings convert into more rupees. A very strong rupee does the opposite. Sudden swings in either direction make it hard for businesses to plan. So the goal is not a fixed number, but orderly movement.

A weak rupee also raises the tax on imports. Customs duty (the tax on goods entering India) and Integrated GST (IGST) on imports are charged on the rupee value of the goods. So a machine priced at USD 1,000 is valued at ₹90,000 when a dollar costs ₹90, but at ₹95,000 when it costs ₹95. The dollar price is the same, but the tax is higher.

To work out the rupee value, customs officers use an exchange rate published by the Central Board of Indirect Taxes and Customs (CBIC). Under Section 14 of the Customs Act, 1962, the rate in force on the day the importer files the bill of entry (the import declaration) applies.

Where did it come from?

After independence, India had a fixed exchange rate. The rupee was first linked to the British pound. From September 1975, it was linked instead to a basket of the currencies of India's main trading partners. The government and the RBI set the rate. In 1991, India faced a severe balance of payments crisis: its foreign exchange reserves could pay for only a few weeks of imports.

The rupee was devalued in July 1991. In March 1992, India brought in the Liberalised Exchange Rate Management System (LERMS). Under it, exporters converted 40% of their earnings at the official rate and 60% at the market rate. From 1 March 1993, the two rates were unified, and India moved to a single market-determined exchange rate. That system continues today.

How does the RBI manage the rupee?

The RBI does not target a fixed rate. It says it intervenes only to curb excessive volatility. Its main tools are:

• Selling or buying dollars in the spot market: If the rupee falls too fast, the RBI sells dollars from its reserves. This increases dollar supply and supports the rupee. If too many dollars come in and the rupee rises too fast, it buys dollars.
• Forward and swap deals: The RBI can agree today to buy or sell dollars at a future date. In a buy/sell swap, it gives dollars now and takes them back later, or the other way round. This also changes the amount of rupees in the banking system.
• Measures to attract dollars: The RBI can allow higher interest rates on non-resident deposits such as FCNR(B) accounts, relax limits on foreign borrowing or investment, or ask exporters to bring money home faster. In 2013, during the "taper tantrum", a special FCNR(B) swap window, together with a similar window for banks' foreign borrowing, brought in about USD 34 billion. Both windows closed at the end of November 2013. The RBI opened a similar FCNR(B) swap window again from 8 June 2026. It bore the cost of hedging (protecting against currency moves), so banks could offer higher rates on these dollar deposits.
• Measures to reduce dollar demand: For example, limiting certain outward payments or gold imports in a crisis. Oil imports are one of the biggest sources of dollar demand. So the RBI can open a special dollar window for public sector oil marketing companies (OMCs): it sells them dollars directly, instead of letting them buy dollars from banks in the open market. India used such a window from 28 August 2013 for Indian Oil, Hindustan Petroleum and Bharat Petroleum. It closed the window at the end of November 2013, once the rupee had steadied. It opened one again for the same three companies from 12 October 2026.
• Rules that curb speculation: Speculation here means betting on the rupee's fall to make a profit. Using its powers under the Foreign Exchange Management Act (FEMA), 1999, the RBI sets rules for banks on rupee derivatives (contracts whose value depends on the exchange rate). It sends these rules to banks through A.P. (DIR Series) circulars. It can cap the size of bets, stop people from rebooking cancelled contracts, or limit the open rupee positions a bank may hold. These rules calm the market without spending reserves.

In 2026, the rupee came under heavy pressure, and the RBI used many of these tools together. The rupee touched a record low of about 96.95 per dollar (during trading) on 20 May 2026. From April 2026, banks' net open position in the rupee was capped at USD 100 million. In October 2026, the RBI cut the limit for rupee derivatives taken without proof of a real need (both with banks and on stock exchanges) from USD 100 million to USD 5 million.

It also made banks keep a Foreign Exchange Risk Reserve (FERR) with it, equal to 20% of certain large rupee derivative deals. On 7 October 2026, the Monetary Policy Committee raised the repo rate (the rate at which the RBI lends to banks) by 0.25 percentage points to 5.50%. Higher interest rates can also support the rupee, because they make rupee assets more attractive to foreign investors.

A simple comparison: think of a river. The RBI does not decide where the river flows. But when the water rushes too fast, it opens or closes the gates of a dam to keep the flow steady. The foreign exchange reserves are the water stored behind the dam.

Foreign exchange reserves: the RBI's ammunition

The RBI manages India's reserves under the RBI Act, 1934 and FEMA. They have four parts:

• Foreign currency assets (the largest part, mostly dollars and other major currencies held in safe assets)
• Gold
• Special Drawing Rights (SDRs), a reserve asset created by the IMF
• Reserve Tranche Position in the IMF, which is India's own quota money that it can draw from the IMF at short notice

India's reserves touched a record of about USD 786 billion in the week ended 4 September 2026. As the RBI sold dollars to support the rupee, they fell to about USD 766 billion by mid-September and about USD 735 billion in the week ended 2 October 2026.

How does the IMF see India's system?

The IMF sorts countries by how their currency actually behaves, not just by what they say. In 2023, it classed India as a "stabilised arrangement", meaning the rupee moved in a very narrow band because of heavy intervention. In November 2025, it moved India to a "crawl-like arrangement", meaning the rupee moves gradually along a trend within a narrow band, with the RBI smoothing the path.

The IMF judges this only from how the rupee actually behaved. It is not the same as a crawling peg, where a country announces in advance the small, regular changes it will make to its rate. India officially describes its regime as market-determined.

Commonly confused concepts

• Depreciation vs devaluation: Depreciation is when a currency loses value because of market forces. Devaluation is when a government deliberately lowers the value under a fixed rate system, as India did in 1966 and 1991.
• Fixed vs floating vs managed float: In a fixed system, the government sets the rate. In a free float, only the market sets it. In a managed float, the market sets it but the central bank steps in to smooth swings.
• NEER vs REER: The Nominal Effective Exchange Rate (NEER) measures the rupee against a basket of trading partners' currencies. The Real Effective Exchange Rate (REER) also adjusts for price differences (inflation) between India and those countries. REER tells us whether Indian goods are becoming more or less competitive.
• Sterilised vs unsterilised intervention: When the RBI buys dollars, it releases rupees into the system. If it then takes those extra rupees back (for example through bond sales or swaps), the intervention is sterilised. This protects its control over interest rates and inflation.

Issues, criticism and the way forward

• The impossible trinity: Economics says a country cannot have all three at once: a fixed exchange rate, free movement of capital, and an independent interest-rate policy. India chooses a flexible rate and partial capital controls to keep monetary policy free.
• Cost of intervention: Selling reserves to defend the rupee reduces the buffer. Buying dollars to stop the rupee rising adds to the stock of rupees and can fuel inflation if not sterilised.
• External criticism: The IMF has at times said India's intervention is more than needed. The Indian government and the RBI have replied that it is needed to prevent disorderly moves.
• Way forward: Experts suggest building a strong export base, encouraging stable long-term inflows like FDI over hot money, promoting trade in rupees, and keeping a healthy reserve buffer, rather than relying only on intervention.

Concepts to Know

• Dollar liquidity: How easily banks and businesses can get dollars in the market. Low dollar liquidity means dollars are scarce and costly.
• Balance of payments (BoP): A record of all money flows between a country and the rest of the world in a period, such as trade, remittances and investments.
• Taper tantrum (2013): A sudden flight of money from emerging markets, including India, after the US central bank hinted it would slow its support to the US economy. The rupee fell sharply then.
• Special Drawing Rights (SDR): An international reserve asset created by the IMF in 1969. Its value is based on a basket of five major currencies.
• Hot money: Short-term foreign money that moves quickly in and out of a country in search of better returns.
• Net open position: The amount of a currency a bank holds that is not matched by an opposite deal. It shows how much the bank gains or loses if the rupee moves. A cap on it limits how big a bet a bank can carry.
• Foreign Exchange Risk Reserve (FERR): Cash that banks must keep with the RBI, equal to 20% of the rupee value of certain large rupee derivative deals (above USD 2 million) where the user buys foreign currency. It makes such deals costlier, which discourages betting against the rupee.