Dollar Demand Drives Long-Term Rupee Weakness Despite RBI Reserves

The Indian Rupee (INR) continues to face pressure from persistent demand for US Dollars, despite the Reserve Bank of India's (RBI) efforts to bolster its reserves. MUFG, a major financial institution, anticipates the USD/INR exchange rate to reach 97.50 by September 2027, reflecting this underlying Dollar demand. Currently, the pair is trading near 96.4031, showing a slight increase from earlier in the week.

Disagreements persist among financial experts regarding the RBI's next steps on interest rates. MUFG expects the RBI to maintain its repo rate at 5.25% during the upcoming October 7 decision, while Goldman Sachs and Morgan Stanley predict a 25-basis-point increase. MUFG's longer-term forecast includes a 50-basis-point hike split between December 2026 and February 2027, potentially raising the repo rate to 5.75%.

The RBI's measures to support the Rupee have attracted over US$140 billion in reserves, enhancing its capacity to intervene in the market. However, MUFG notes that this accumulation does not immediately translate to Dollar sales in the market, only increasing the RBI's reserve stock. Foreign investors repatriating investment proceeds and a robust pipeline of initial public offerings continue to drive Dollar demand, pushing the USD/INR higher in the long term.

Despite the RBI's stronger defenses against a disorderly sell-off, MUFG expects the Rupee to weaken later in 2027, even after anticipated rate increases. The bank highlights the challenge of managing excess liquidity created by these foreign exchange measures, which could further complicate the RBI's policy decisions.