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Why the Indian Rupee Is Not Appreciating Despite Rising Foreign Exchange Reserves

India’s foreign exchange reserves have surged to an impressive $700 billion, a significant achievement for the economy. This accumulation is largely due to capital inflows, remittances, and rising exports. However, despite this increase in reserves, the Indian rupee (INR) has not been appreciated as one might expect. The question arises: why is the rupee still relatively weak, and what should be the best foreign exchange policy in this scenario?

The Link Between Foreign Exchange Reserves and Currency Appreciation

Typically, when a country accumulates large foreign exchange reserves, it strengthens investor confidence in the economy, leading to upward pressure on the currency. A strong reserve base implies that the country can meet its import obligations, repay foreign debt, and manage currency volatility. Ideally, this should result in currency appreciation as demand for the local currency increases.

However, in India’s case, despite its robust reserve position, the rupee has not shown significant appreciation. There are several reasons for this:

1. Inflationary Pressures

India has been grappling with inflation, primarily due to rising global commodity prices and domestic supply chain disruptions. A high inflation rate makes a currency less attractive to investors, as it erodes purchasing power. Thus, even with growing reserves, the rupee remains under pressure due to domestic inflation.

2. Central Bank Intervention

The Reserve Bank of India (RBI) has a dual mandate: maintaining price stability and ensuring economic growth. To support exports, the RBI often intervenes in the currency market to prevent the rupee from appreciating too much. A stronger rupee makes Indian exports less competitive, particularly in a global market where price sensitivity is high. The RBI may purchase foreign currencies (usually the U.S. dollar) to stabilize or even depreciate the rupee, thereby supporting the export sector.

3. Current Account Deficit (CAD)

India has historically run a current account deficit, meaning it imports more than it exports. While capital inflows (such as foreign investments and remittances) have helped bridge this gap, a persistent CAD keeps the rupee under pressure. When a country is a net importer, there is a continual demand for foreign currencies to pay for imports, which can limit the rupee’s appreciation.

4. Global Economic Environment

Global economic uncertainties, such as the Federal Reserve’s interest rate hikes, have made investors cautious about emerging markets. Higher interest rates in developed countries make their bonds and securities more attractive, resulting in capital outflows from countries like India. This weakens the rupee despite the increasing foreign exchange reserves.

5. Geopolitical Risks

The global economic environment is also shaped by geopolitical risks, such as ongoing tensions in Europe, China-U.S. relations, and global supply chain disruptions. These factors cause investors to hedge against risks by keeping their capital in safer currencies like the U.S. dollar, preventing any significant appreciation of the rupee.

What Should Be the Best Foreign Exchange Policy?

In this scenario, India should carefully craft its foreign exchange policy to balance economic growth, export competitiveness, and inflation control. Here are some key considerations:

1. Controlled Appreciation

A gradual and controlled appreciation of the rupee can be beneficial, as it can reduce the cost of imports (especially oil, which is a major component of India’s import bill), thus easing inflationary pressures. However, this needs to be managed carefully to avoid hurting the export sector. A policy of allowing mild appreciation while using reserves to absorb excess volatility can be a sound approach.

2. Diversification of Reserves

With $700 billion in reserves, India should focus on diversifying its holdings. Instead of holding predominantly U.S. dollars, the RBI could consider adding more euros, yen, and gold to its reserves. This would reduce exposure to the fluctuations of a single currency and enhance returns from reserves. Diversification is essential for managing geopolitical risks and maximizing returns on foreign exchange reserves.

3. Boosting Domestic Growth

Strengthening the domestic economy should be a priority, which would also help strengthen the rupee organically. Policies aimed at boosting domestic manufacturing, improving infrastructure, and promoting innovation can help reduce the current account deficit in the long run by reducing import dependency and increasing export competitiveness.

4. Capital Account Liberalization

With a strong reserve buffer, India can explore gradual liberalization of its capital account to attract more foreign investments in sectors like infrastructure, renewable energy, and technology. However, this needs to be a cautious approach, ensuring that short-term speculative inflows do not create instability in the currency markets.

5. Currency Swap Agreements

India should also explore more currency swap agreements with trading partners. This would allow trade to take place in local currencies rather than relying on the U.S. dollar, thereby reducing the demand for foreign currency and supporting the rupee’s value.



India’s burgeoning foreign exchange reserves offer an excellent opportunity to strengthen its economic resilience, but an overly strong rupee could hamper export-led growth. The best foreign exchange policy in this scenario is a balanced one that allows for controlled appreciation, inflation management, and continued support for the export sector. By focusing on strategic reserve management, domestic growth, and smart capital flows, India can maintain a stable and competitive currency, bolstering its economic position on the global stage.