Why RBI Isn’t Defending the Rupee: The ‘Impossible Trilemma’ Behind India’s Currency Slide

Why RBI isn't targeting Rupee's price band — the 'impossible trilemma' explained

In early December 2025, the Indian rupee hit an all-time low—breaching the psychological barrier of ₹90 to the US dollar. Markets braced for intervention. Traders expected the Reserve Bank of India (RBI) to rush in with billions from its foreign exchange reserves to prop up the currency. But nothing happened.

Instead, RBI Governor Shaktikanta Das and his team remained calm, reiterating their primary focus: inflation control. To the public, this might seem like indifference. But behind this restraint lies one of the most fundamental—and unforgiving—principles in international economics: the ‘impossible trilemma.’ Understanding this concept is key to decoding the RBI rupee policy in today’s volatile global environment.

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What Is the ‘Impossible Trilemma’?

Also known as the ‘trilemma of international finance,’ this economic principle states that a country cannot simultaneously achieve all three of the following:

  1. Fixed exchange rate (e.g., defending the rupee at ₹85),
  2. Free movement of capital (allowing investors to move money in and out freely),
  3. Independent monetary policy (setting interest rates based on domestic needs like inflation).

You can pick any two—but never all three. This isn’t a theory; it’s a hard constraint backed by decades of global financial history .

India, like most major emerging economies, has chosen options 2 and 3: it allows relatively free capital flows and maintains an independent monetary policy focused on price stability. The trade-off? It must accept a flexible exchange rate—meaning the rupee’s value is largely determined by market forces.

RBI Rupee Policy: Why Defense Takes a Backseat

So when the rupee slid to ₹90, why didn’t the RBI step in aggressively?

The answer is simple: because doing so would undermine its core mandate. Every dollar the RBI spends to buy rupees reduces liquidity in the system, which can push interest rates higher—or force the central bank to print more money, risking inflation. In a world where food and fuel prices are already volatile, the RBI simply cannot afford to lose control of domestic price levels .

That said, the RBI isn’t completely hands-off. It uses what economists call “leaning against the wind”—small, calibrated interventions to smooth excessive volatility, not to target a specific price band . This approach preserves credibility without sacrificing monetary autonomy.

The Real Priority: Inflation Control Over Currency Stability

As of late 2025, India’s retail inflation hovers around 5.4%—above the RBI’s 4% target but within the 2–6% tolerance band. However, with global oil prices surging and supply chains under strain, the risk of a second-round inflationary spike is real.

By prioritizing inflation, the RBI is protecting household purchasing power and long-term economic stability. A weaker rupee does make imports costlier, but it also boosts exports—a natural adjustment mechanism. Over time, this balance helps the economy absorb external shocks without triggering a crisis.

How Global Forces Are Pressuring the Rupee

The rupee’s fall isn’t happening in a vacuum. Several external factors are at play:

  • Strong US Dollar: The Federal Reserve’s prolonged high-interest-rate stance has made the dollar attractive globally.
  • Global Risk Aversion: Geopolitical tensions and recession fears have driven investors toward safe-haven assets, away from emerging markets.
  • India’s Current Account Deficit: While manageable, a widening deficit increases reliance on foreign capital, making the rupee vulnerable during outflows .

In this context, trying to artificially hold the rupee at ₹85 would be like bailing out a sinking boat with a teaspoon—it might delay the inevitable, but at great cost.

What Happens If RBI Intervenes Too Much?

History offers cautionary tales. In 1991, India’s attempt to defend an overvalued rupee drained foreign reserves to just weeks’ worth of imports—triggering a full-blown balance of payments crisis that required an IMF bailout .

More recently, countries like Turkey and Sri Lanka suffered severe economic turmoil after trying to maintain unrealistic exchange rates while ignoring inflation and fiscal deficits. The lesson? Fighting market fundamentals is a losing battle.

Historical Context: India’s Past Currency Crises

India has learned hard lessons from its past. Post-1991 reforms shifted the economy toward flexibility and resilience. Today, India holds over $600 billion in forex reserves—enough to cover nearly 12 months of imports—giving the RBI ample buffer to manage volatility without panic .

This strength allows the central bank to adopt a patient, strategic stance rather than reactive firefighting. As former RBI Deputy Governor Viral Acharya once noted, “A flexible exchange rate is India’s shock absorber.”

Conclusion: A Strategic Silence, Not a Failure

The RBI’s decision not to defend a specific rupee level isn’t weakness—it’s wisdom born of economic realism. By respecting the impossible trilemma and prioritizing inflation control, the central bank is safeguarding India’s long-term macroeconomic health. Yes, a weaker rupee hurts importers and fuels headlines. But a stable, credible monetary framework protects everyone. For deeper insights into India’s economic strategy, explore [INTERNAL_LINK:india-monetary-policy-explained].

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