Rupee Under Siege: How Geopolitics and RBI Policy Are Shaping India's Currency Crisis

The Indian rupee (INR) has faced significant downward pressure in early 2025, driven by escalating India-Pakistan tensions and shifting monetary policy from the Reserve Bank of India (RBI). Recent military actions, including India’s strikes against targets in Pakistan and retaliatory measures, have heightened geopolitical risks, while the RBI’s pivot toward a more flexible exchange rate regime has amplified currency volatility. Investors now grapple with the dual pressures of regional instability and central bank policy shifts, with the INR depreciating sharply against the U.S. dollar.

A Geopolitical Flashpoint Sparks Currency Turmoil

The crisis began on April 23, 2025, when a terrorist attack in India-administered Kashmir killed 25 Hindu tourists. The Resistance Front (TRF), a Pakistan-linked militant group, claimed responsibility, prompting India to accuse Pakistan of harboring terrorists. In response, India expelled Pakistani diplomats, suspended key treaties like the Indus Waters Treaty, and conducted military strikes on nine Pakistani sites on May 7, 2025, targeting alleged terror infrastructure.

This escalation triggered immediate market reactions:
- The INR fell 1.8% against the USD in three trading sessions, closing at ₹83.45 per USD by mid-April.
- Foreign capital fled: Portfolio investors withdrew ₹3,000 crore from Indian equities and bonds, mirroring the aftermath of the 2019 Pulwama attack.
- Oil prices surged: Global crude prices rose amid Middle East tensions, worsening India’s trade deficit (which relies on imports for 83% of its oil needs).

RBI’s Policy Shift: Flexibility vs. Stability

The RBI’s response has further fueled rupee volatility. Under new Governor Sanjay Malhotra, the central bank has abandoned former Governor Das’s “rupee stability” mantra for a more flexible exchange rate policy, allowing the currency to depreciate freely. This shift, combined with reduced forex market interventions, has:
- Corrected overvaluation: The rupee’s trade-weighted real effective exchange rate (REER) had reached 108.14 by November 2024—its highest since 2004—making Indian exports uncompetitive.
- Increased volatility: The rupee’s 30-day realized volatility hit a six-month high in December 2024, with the currency dipping to ₹85.8075 against the USD.

However, the RBI faces a delicate balancing act. While depreciation could boost export competitiveness, it risks:
- Inflation spillovers: Rising oil prices and supply chain disruptions could push inflation above the RBI’s 4% tolerance range.
- Capital flight: A weaker rupee may deter foreign investors, worsening India’s current account deficit (CAD), which stood at -2.4% of GDP in 2023-24.

Market Reactions: Gold Rush and Equity Volatility

Investors have already begun hedging against rupee weakness:
- Gold demand surged: Prices crossed ₹1,00,000 per 10 grams in major cities, with retail allocations to gold ETFs rising by 35% post-April 23.
- Equity markets held steady: The Nifty 50 and BSE Sensex remained near support levels, but midcap stocks and tourism-related sectors faced pressure.

Meanwhile, the RBI’s delayed rate cuts have drawn scrutiny. Analysts had anticipated a 25-50 basis point rate reduction in 2025 to support growth, but geopolitical risks may force the central bank to prioritize currency stability instead.

Conclusion: Navigating the Crossfire

The rupee’s trajectory hinges on two critical factors:
1. Geopolitical De-escalation: A 10-15 day cooling-off period could stabilize markets, but prolonged conflict risks pushing the INR to ₹85/$ or beyond by late 2025.
2. RBI’s Policy Tightrope: The central bank’s $686 billion forex reserves provide a buffer, but balancing external pressures (trade deficits, capital flight) with domestic growth needs will test its credibility.

For investors, the risks are clear:
- Short-term volatility: The rupee’s flexibility and geopolitical uncertainty will keep the currency volatile.
- Long-term fundamentals: India’s $3.2 trillion economy and strong GDP growth (projected at 6.7% in FY2026) could underpin recovery—if the RBI manages the rupee’s decline without triggering hyperinflation.

In short, the rupee’s fate in 2025 is a geopolitical and economic high-wire act. Investors must weigh the RBI’s policy tools against the region’s enduring instability—a balancing act with global consequences.