The RBI added another layer to its rupee defence strategy over the weekend, unveiling fresh FX and liquidity measures(see note). Steps revolved around curbing speculative demand, tightening regulations around FX derivative contracts and diverting oil dollar demand away from the spot market to stabilise the currency. Rupee rallied close to 1% at open, with attempts to return towards 96/USD thereafter attracting intervention bids. The breadth of the restrictions points to the record low of 97.00 as a de facto policy red line for USD/INR in the near-term. Back in 2013, the INR had depreciated sharply in the run-up to measures in July but appreciated thereafter due to a combination of macroprudential measures, rate response as well as resumption in inflows and the US Fed’s decision to pause on rates. To that extent, a durable turnaround in the currency will also require negative global triggers to subside. The latest announcements may not fully quell speculation over further policy action. Should depreciation pressures intensify again, markets are likely to price a higher probability of a front-loaded and more aggressive rate-hike cycle.
Accompanying liquidity measures – raising the daily minimum CRR requirement and OMOs - are consistent with the RBI’s 7 October signal that excess system liquidity would be progressively drained to keep overnight money-market rates anchored closer to the repo rate, reinforcing the tightening cycle. The surplus slipped below INR 4trn by late last week and ahead of temporary drain on the cash balances by way of currency leakage, tax outflows, and FX intervention sales. More tranches of open market operations are likely in the making, with markets anticipating a total of INR 1.0-1.5trn this quarter. Against this backdrop, the 10y bond yield neared a three-year high on Monday, as RBI’s liquidity measures fuelled the sell-off. On the markets end, foreign reserves have come off high but are still substantial, with the import cover at a comfortable ~10 months of import cover. In the near-term, barring a rollback of these macroprudential restrictions, USDINR is likely to be rangebound within 95.20-96.20, while bond yields will be firm due to ongoing liquidity measures, firm oil prices and elevated global yields.
September inflation rose to 5.5% yoy, lower than our forecast at 5.7%, but at the fastest pace since late-2024. Food inflation will continue to be a key variable for the headline in midst of below normal monsoon and El Nino impact, with pressures broadening beyond perishables to pulses, sugar, edible oil, cereals etc. Core inflation strengthened to 4.5% yoy from 4.3% in Aug (and 3.1% in Jan26), while the share of the inflation basket running above 4% rose to ~36% by Sep26. 3QFY (Oct-Dec) inflation is expected to edge past 6% on a low base as well as broader pressures from food, fuel and services. A gradual rise in the core gauge aligns with the central bank's view that price risks are no longer benign. In the face of higher headline prints, we expect the RBI to keep the door open for another rate hike in December 2026.
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