Markets can be irrational in the short run: What RBI Governor Sanjay Malhotra said as rupee nears lifetime low

Rupee dropped closer to a record low against the US dollar on Wednesday after the Reserve Bank of India (RBI) announced its first rate hike in nearly four years. However, the central bank’s Governor Sanjay Malhotra believes that the Indian currency may be undervalued.

“Financial markets can be irrational in the short run. It is only in the long run they are able to find the right value," Malhotra said during the post policy press conference. "By a number of estimates, including the REER (real effective exchange rate), the rupee...may be undervalued," he added, while responding to a question on why currency polls and hedging behaviour continued ⁠to point to a rupee depreciation bias.

The RBI will ensure that rupee stabilises and finds its value, and the central bank will support the Indian currency in orderly movement in finding its correct value, Malhotra said. “We will ensure there's no excessive volatility.”


Also read | RBI hikes rate, but analysts see shift to ‘calibrated tightening’ as bigger takeaway. How can this impact markets?

The rupee dropped to 96.8450 against the US dollar, nearing its record low of 96.96 hit in May. Market analysts feel RBI rate hike reflects rising cyclical inflation risks while the shift in stance to 'calibrated tightening' alongside higher growth and inflation projections highlights the MPC's hawkish approach.

What analysts say

The RBI's 25 bps hike to 5.50% is defensible, and the shift to "calibrated tightening" matters more than the rate itself because it rules out near-term cuts, said Sumit Singhania, Head of Research at Bajaj Broking.

“With CPI rising to 4.8% in August and projected at 6% in Q3, at the upper edge of the tolerance band, acting now makes sense. Growth projected at 7.1% gives the economy room to absorb it. The global backdrop adds to the case. The US Fed hiked in September, and markets still price in a further hike by December, with the October 28 FOMC acting as a live risk,” the analyst highlighted, adding that this keeps pressure on the rupee and limits the RBI's room to stay accommodative.

"The RBI's October hike acknowledges that cyclical inflation risks are no longer benign. The change in stance also underscores the RBI MPC's hawkish intent and is reinforced by upward revisions to growth and inflation forecasts," said Radhika Rao, Senior Economist and Executive Director, DBS Bank.

The analyst noted that the combination of higher inflation forecasts and calibrated tightening should keep front-end rates biased higher. The policy shift meanwhile is modestly constructive for the rupee, as wider rate differentials and a tightening bias bolster the currency's resilience to external shocks, even as a stronger US dollar remains a headwind, Rao added.

Also read | Indian rupee FX premiums jump after RBI policy leaves traders bracing for more sell/buy swaps

(With inputs from agencies)

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