The Indian Rupee's Steadfast Dance: Navigating Carry Trades in a Range-Bound USD/INR Landscape

The Indian rupee (INR) has carved out a remarkable niche in 2025, maintaining its composure against the U.S. dollar within a tight 85-87 range despite geopolitical turbulence and shifting Federal Reserve (Fed) signals. This resilience, fueled by a weakening U.S. dollar, fading Middle East risk premiums, and India's robust policy adjustments, has created a compelling backdrop for carry trades. Yet, beneath the surface lies a delicate balance between opportunity and risk.

The Foundation of the Range-Bound USD/INR

The State Bank of India (SBI) has consistently projected the USD/INR to remain anchored between 85 and 87 in 2025, citing three pillars of stability:
1. U.S. Dollar Exceptionalism Wanes: The DXY index, which measures the greenback's strength against major currencies, has declined as the Fed signals caution. With U.S. inflation dipping to 2.4% in March 2025 and unemployment stable at 4.2%, the Fed is unlikely to raise rates further, easing downward pressure on the INR.
2. Geopolitical Risk Mitigation: The Iran-Israel ceasefire in June 2025 reduced short-term volatility, though lingering tensions persist. This has dampened risk premiums, allowing the INR to stabilize.
3. India's Policy Fortitude: The Reserve Bank of India (RBI) has maintained a neutral stance, with a repo rate of 5.50%, while tackling imbalances like a widening current account deficit (1% of GDP) through measures such as gold import duty hikes.

The Non-Deliverable Forward (NDF) market reinforces this outlook. As of June 2025, the May 2026 NDF contracts price in a rate of 85.87–86 INR/USD, signaling little volatility expectation. This aligns with SBI's forecast, suggesting traders are pricing in a risk-on environment for the rupee.

Carry Trade Opportunities: Riding the Rate Differential

The yield advantage of Indian assets over U.S. equivalents makes carry trades attractive. India's 5.50% repo rate versus near-zero Fed rates creates a 500-basis-point spread, offering investors a risk-reward sweet spot.

Strategic Play:
- Borrow in USD, invest in INR-denominated debt (e.g., RBI bonds or corporate paper) to capitalize on the rate differential.
- Hedge currency risk using NDF contracts to lock in rates near 85.8–86, limiting downside exposure.

The SBI's Q2 2025 forecast of 85.7–85.9 INR/USD creates a high-probability trading corridor. Traders could enter long INR positions when the pair dips to 85.8, targeting gains toward 85.5 while maintaining stop-losses below 86.2.

Risks to the Rally: Crude Volatility and Trade Tensions

While the INR's stability is encouraging, two critical risks loom:
1. Crude Oil Prices: India's reliance on oil imports (accounting for ~25% of its trade deficit) makes it vulnerable to price spikes. A return to $80+ per barrel could push the USD/INR toward 87.5, as seen in the IndiaPulse forecast.
2. Trade Reciprocity: U.S. threats of 15% tariffs on Indian goods—targeting sectors like pharmaceuticals and electronics—could disrupt trade flows and weaken the INR. A delayed resolution risks a 5–7% devaluation by year-end.

Positioning for Short-to-Medium-Term Gains

Investors should adopt a layered strategy to balance reward and risk:
- Core Position: Allocate 30–40% to INR-denominated bonds (e.g., 10-year government paper yielding ~6.8%) for steady income.
- Speculative Overlay: Use NDF contracts to short USD/INR at 85.8–86, leveraging the Fed's pause and India's policy tools. Target a 5% return by year-end.
- Hedge Exposure: Pair INR bets with long positions in gold (to offset inflation risk) or short oil futures to mitigate crude volatility.

Conclusion: A Dance of Delicate Balance

The INR's stability in 2025 is no accident—it reflects a deliberate policy response to global headwinds. Carry trades remain viable, but success hinges on nimble hedging and close monitoring of crude prices and trade talks. For now, the 85–87 range offers a safe harbor for investors willing to navigate the geopolitical currents.

As the year progresses, a ceasefire in the Middle East, a Fed rate cut, or a U.S.-India trade pact could shift the landscape. Stay alert, stay hedged—and keep dancing.