Reserve Bank confronts shrinking policy space as rupee rout leaves few good options

New Delhi: The Reserve Bank of India walks into this week’s monetary policy meeting with its manoeuvring room dramatically reduced, boxed in by a rupee that has slipped past 90 to the U.S. dollar and a market that no longer believes the central bank can do everything at once. The currency’s drop to 90.15 on Wednesday — its weakest level ever — has forced the RBI into a corner where every policy choice car-ries an unusually high risk of collateral damage. Even as the economy posts headline growth above 8 per cent and inflation has collapsed to near-zero, the rupee has become the single variable dominating the MPC’s calculus.

The fall has been sharper than the macro backdrop would suggest. Traders say the RBI has intervened in “light-touch” fashion, stepping in briefly rather than signalling an unambiguous defence. That has created the impression — fair or not — that the central bank is willing to absorb more depreciation for the sake of preserving liquidity. But the consequences of that perception are now landing in real time: importers have rushed to cover exposures, exporters have delayed conversions, hedging costs have widened, and speculative interest around the 91 level has grown louder. The longer the RBI stays am-biguous, the more one-way the market becomes.

This currency slide has arrived at exactly the wrong moment for the MPC. Until a month ago, the December meeting looked like the safest window for a final 25-basis-point cut, with inflation at a decadal low of 0.3 per cent and liquidity rebuilt after months of tightness. Real policy rates remain above the RBI’s own neutral estimates, and growth — though strong in the June and September quarters — is ex-pected to soften as the boost from front-loaded exports fades. By all conventional logic, the RBI should have been able to ease. But the logic has been overtaken by external fragility. FPI outflows from equities have persisted despite Federal Reserve cuts, the trade deficit has blown past $40 billion, and the 50 per cent U.S. tariff regime still hangs without clarity. CRISIL’s reading of the external account shows Q2’s narrower CAD owes more to suppressed imports than meaningful export resilience. Dollar de-mand remains elevated, and gold imports have added an old vulnerability back into the mix.

The result is a policy trap. If the RBI cuts rates now, it risks accelerating the rupee’s decline exactly when markets are testing how far the central bank will let the currency slide. A cut would reinforce the narrative that the RBI is prioritising growth over stability, potentially fuelling another wave of carry un-winds and speculative bets against the INR. Even a modest imported-inflation bump — 20 to 30 basis points — would undo much of the year’s hard-won disinflation credibility. Bond markets may applaud a cut, but equity markets and foreign investors are already signalling discomfort, and a rate reduction could turn that unease into exit flows.

But holding rates is not a clean solution either. A pause risks tightening financial conditions at a time when credit growth is beginning to recover and liquidity, though comfortable at ₹1.8 trillion, remains sensitive to outflows triggered by FX intervention. If the RBI mounts a heavy-dollar defence to stabi-lise the rupee, it will end up draining liquidity and undermining the very transmission it has spent months rebuilding through CRR cuts and open-market purchases. A firm defence of the currency could also raise yields, countering the modest softening that began after India’s bond index inclusion be-came more certain. In effect, stabilising the rupee could destabilise the domestic money markets; supporting the money markets could further weaken the rupee.

That leaves the RBI with a narrow corridor of imperfect options: a pause paired with dovish forward guidance, silent but heavier FX intervention, a temporary liquidity offset via OMOs, or a combination of all three. Each carries costs. A dovish pause buys time but does little to change currency sentiment. Heavy intervention risks being interpreted as panic unless accompanied by a convincing narrative. Li-quidity injections risk stoking speculation and widening the rupee’s downside. And verbal intervention — the tool central banks often use — may not carry much weight in a market that has already seen the 90 level breached.

The deeper worry is that the rupee’s slide is exposing structural weaknesses that monetary policy cannot paper over. Despite a 50 per cent depreciation over the past decade, India has not seen the kind of export surge classical economics predicts. Input tariffs remain elevated, quality-control orders have become a friction point, and logistics costs are still high enough to erode any notional pricing ad-vantage. The export engine has simply not responded, and that failure leaves the rupee more vulner-able whenever global conditions tighten. It is this disconnect — strong domestic data, weak external traction — that leaves the RBI with such a narrow set of defensible moves.

As the MPC deliberates, the central bank knows it is no longer choosing between a cut and a pause. It is choosing between signalling confidence in a fragile external moment or signalling caution that could stifle the very economic momentum the growth numbers seem to celebrate.

It is choosing between protecting the rupee today and protecting monetary credibility over the next year. And with the cur-rency hovering near uncharted territory, the RBI knows the margin for error has shrunk to its smallest since the taper tantrum years.

Whatever path it announces on December 5 will not just be a policy de-cision; it will be a judgement call on which risk India can afford to carry longer — a weakening currency or a weakening monetary stance.