Is the new low just the beginning? Former Indian central bank officials hint at "relaxing foreign exchange controls," how much further will the rupee fall?

The Indian Rupee hits a new low again, Mitsubishi UFJ warns that under triple pressure, the Indian Rupee will fall below the 88 mark by the end of the year.

On January 6, the Indian Rupee faced another sell-off, with the exchange rate against the US dollar briefly falling below the 86 mark during the day, reaching a low of 86.006, setting a historical low. As of the time of writing, it was reported at 85.696. Over the past year, the Rupee has set a series of new lows, with depreciation intensifying in December, rising from 84.50 to 85.72.

In terms of news, according to media reports, former Deputy Governor of the Reserve Bank of India (RBI) Viral Acharya stated in an interview that the Indian central bank should relax its strict control over the Rupee exchange rate. This view has sparked speculation in the market about whether the new central bank governor will continue the previous restrictions on currency fluctuations.

Before this view was expressed, Mitsubishi UFJ downgraded its Rupee forecast in a report last Thursday, predicting that the USD/INR will rise to 86.80 in the first quarter of 2025 and to 88.50 in the fourth quarter, mainly based on the continued deficit pressure on the balance of payments in the first half of 2025, disappointing foreign capital inflows, and external factors such as the Trump 2.0 tariff risk.

Former Central Bank Official Suggests "Relaxing Foreign Exchange Controls"

Acharya believes that "the central bank does not need to completely eliminate volatility to manage excessive fluctuations." He emphasized that allowing a certain degree of fundamental volatility is important, as it can maintain a certain level of private hedging, and the central bank cannot absorb all risks completely.

At the time this view was released, the market was waiting to see whether the new central bank governor Sanjay Malhotra would continue the previous administration's active intervention in the foreign exchange market. Despite the Rupee hitting historical lows multiple times last year, it remains one of the most stable currencies among Asian emerging markets, becoming a popular high-yield arbitrage currency. It is worth noting that the volatility of the Rupee has increased in recent weeks, mainly due to the strengthening of the dollar and the widening trade deficit.

Acharya served as Deputy Governor from January 2017 to July 2019, during the first term of Trump. He recalled that during that period of US interest rate hikes and escalating US-China trade tensions, the Indian central bank decided "not to excessively invest at all costs to defend the Rupee exchange rate."

We realized that a certain degree of depreciation must be allowed to partially absorb macroeconomic pressures, essentially providing the economy with some buffer space.

In addition, India's foreign exchange reserves have fallen from a record high of $705 billion in September last year to $640.3 billion as of December 27, marking an eight-month low. In this regard, Acharya warned: "No matter how large your reserve stock is, if a significant portion is lost in the short term, it will not send a good signal to the market."

Under Triple Pressure, the Rupee is Expected to Continue to Fall in 2025

Mitsubishi UFJ's analysis and forecast indicate that India's balance of payments may continue to show a deficit in the first half of 2025, driven by the following factors:

1. First, the current account deficit as a percentage of GDP has been revised up from the previous forecast of 1.2% to 1.5% (FY 2024/25) and 1.4% (FY 2025/26). This is mainly due to the growth in gold imports being much stronger than expected; although service exports have improved, the goods trade deficit remains a major drag.

1. Secondly, foreign direct investment (FDI) performance has been disappointing. Despite a slight improvement in total FDI inflows to India, the withdrawal of foreign capital and increased overseas investments by Indian companies have led to net direct investment outflows. There may be some improvement in 2025, but it remains a pressure point in the short term.

1. Global factors are not entirely supportive, with the risk of a Trump 2.0 tariff and a more hawkish Federal Reserve. Local factors also indicate that the trade-off between growth and inflation is less optimistic for India. Although India may be included in the Bloomberg Global Aggregate Bond Index in the second half of 2025, which is expected to bring in an additional USD 10-15 billion in inflows, global risks and the stickiness of U.S. interest rates remain potential obstacles.

In addition, Mitsubishi UFJ believes that although the Reserve Bank of India’s foreign exchange policy may become less interventionist, allowing the Indian rupee to depreciate appropriately, it is unlikely to completely let the Indian rupee float freely. Policies such as increasing the gold import tax, providing foreign exchange swap windows for oil companies, and export conversion rules will help manage the weakness of the Indian rupee. Mitsubishi UFJ continues to forecast a 75 basis point rate cut by the Reserve Bank of India but has delayed the timing of the rate cut to accommodate the weakened outlook for the Indian rupee