Rupee Surge May Be Short-Lived as Traders See Weakness Ahead

Indian Rupee's Surge Faces Short-Term Challenges as Monetary Easing Looms

India's substantial one-day surge in the rupee, its most significant in nearly two years, has left market observers surprised. However, experts predict that the gains could be short-lived due to anticipated monetary easing and increased global volatility.

DBS Bank anticipates a currency decline to 88.8 per dollar by mid-2025, while IDFC First Bank projects a drop to 89.50 by December. The rupee recently recorded its strongest single-day performance since March 2023 before stabilizing at 86.89 on Wednesday.

This recent volatility marks a shift from the previous stability experienced over the past two years, testing the tolerance of newly appointed central bank chief Sanjay Malhotra in managing foreign exchange market fluctuations. The Reserve Bank of India (RBI) reportedly intervened to suppress speculation, with some speculating around $11 billion was injected over two days.

Analysts anticipate that the central bank will not maintain such a high level of support, as focus shifts to easing policy and boosting liquidity in the financial system. Data released on Wednesday showed that India's inflation moderated to a five-month low in January, bolstering expectations for further rate cuts in the coming months.

"We remain mildly negative on the rupee in the three- to six-month period," said Jeff Ng, head of Asia macro strategy at Sumitomo Mitsui Banking Corp. "RBI rate cuts and increased flexibility in currency movements may result in slight rupee weakness."

The rupee's rally on Tuesday triggered stop losses and fueled speculation that Indian authorities were signaling a conciliatory stance on the currency, anticipating an upcoming meeting between Prime Minister Narendra Modi and President Donald Trump. India is vulnerable to the potential impact of Trump's tariffs, and a stronger rupee could alleviate concerns about its effect on trade.

However, the outlook for the rupee remains uncertain, as the dollar continues to strengthen amid a slower pace of US interest rate cuts. Foreign investors have withdrawn approximately $10 billion from Indian equities this year, exacerbating concerns stemming from slower economic growth and weak corporate earnings.

Dollar-rupee risk reversals, a measure of the premium to protect against dollar strength in the options market, have declined. "We are not observing any market participants expecting significant downside pressure on USD/INR," said Saurabh Tandon, global head of FX options at Standard Chartered Plc in Singapore. "While some profited from the rupee's recent surge, the broader outlook for further appreciation persists."

Tight liquidity conditions in India could also limit the central bank's intervention in the foreign exchange market. The RBI has been increasing its cash injections to alleviate liquidity constraints, and additional dollar sales would further deplete rupee liquidity.

"Every policy action involves trade-offs, and intervention entails the potential drawback of reducing liquidity in the system," said Michael Wan, senior currency analyst at MUFG Bank Ltd. "As a result, the central bank may need to tolerate a weaker rupee over time."