The Rupee Under Siege: Geopolitical Tensions and the RBI’s Balancing Act

The Indian rupee has come under significant pressure in recent weeks, as escalating India-Pakistan tensions and military strikes threaten to destabilize regional and global economic dynamics. With the Reserve Bank of India (RBI) deploying measures to stabilize currency volatility, investors now face a critical question: Can monetary policy offset the risks of prolonged geopolitical strife?

The Geopolitical Backdrop: Conflict and Economic Costs

The recent military escalation began in May 2025, following a deadly militant attack in Indian-administered Kashmir that killed 26 tourists. In retaliation, India launched Operation Sindoor, targeting nine sites in Pakistan-administered Kashmir and Punjab. While India claims its strikes were “focused and non-escalatory,” Pakistan responded by accusing India of violating sovereignty, closing airspace to Indian carriers, and shelling along the Line of Control (LoC).

The immediate economic fallout has been severe:
- Aviation Costs: Indian airlines face an estimated $600 million annual cost increase due to rerouted flights.
- Water and Energy Risks: India’s suspension of the Indus Water Treaty threatens Pakistan’s agriculture (90% of irrigation relies on shared rivers) and hydropower.
- Tourism Collapse: Kashmir’s tourism sector, contributing 7% to regional GDP, has been devastated by violence and travel bans.

Historically, military conflicts have been economically ruinous. During the 2001–2002 standoff, India spent $1.8 billion, while Pakistan spent $1.2 billion. Adjusted for inflation, a modern conflict could cost India $1 billion daily, potentially doubling its fiscal deficit.

The RBI’s Monetary Response

To counter currency weakness, the RBI has taken a dual approach:
1. Policy Rate Cuts: In April 2025, the Monetary Policy Committee (MPC) reduced the repo rate to 6% (from 6.25%), marking the second cut in the fiscal year. This shift to an accommodative stance aims to stimulate growth and ease borrowing costs.
2. Liquidity Management: The RBI injected ₹6.9 lakh crore ($84.5 billion) into the banking system in March 2025, creating a liquidity surplus of ₹1.5 lakh crore by April 7. This stabilized short-term borrowing costs.
3. Foreign Exchange Reserves: India’s reserves stood at $676.3 billion as of April 2025, providing a buffer against external shocks.

Despite these measures, the rupee fell to 84.83 against the dollar on May 10, 2025—a 0.5% decline from the prior session—amid fears of further escalation. Traders speculate the RBI may intervene directly if volatility becomes “disorderly,” though it has emphasized a non-interventionist stance unless necessary.

Market Risks and Investor Sentiment

The conflict’s economic risks extend beyond direct military costs:
- Capital Flight: Previous incidents, such as the 2019 Pulwama attack, triggered ₹30 billion ($400 million) in foreign portfolio outflows. Moody’s now projects India’s 2025 GDP growth at 6.3%, down from earlier estimates, citing geopolitical risks.
- Infrastructure Delays: Defense spending has already diverted funds from projects like the Delhi-Mumbai Industrial Corridor, risking industrial output and employment.
- Global Trade Concerns: Pakistan’s narrow tax base (tax-to-GDP ratio of 9%) and limited reserves ($16.02 billion) amplify its vulnerability, potentially destabilizing regional trade.

The Outlook: Can Stability be Restored?

The RBI’s toolkit is robust, but geopolitical risks remain the wildcard. Key considerations for investors include:
1. Geopolitical De-escalation: A return to dialogue could ease capital flight and stabilize the rupee. However, both nations face domestic pressures to appear strong, complicating negotiations.
2. Monetary Policy Efficacy: Further rate cuts may be needed if inflation remains subdued (projected at 4.0% for FY2025–26). However, prolonged conflict could force the RBI to prioritize stability over growth.
3. External Shocks: A U.S. Federal Reserve policy shift or a spike in oil prices (India imports 85% of its crude) could amplify rupee weakness.

Conclusion

The rupee’s trajectory hinges on whether the RBI’s measures can offset the dual pressures of geopolitical instability and global macroeconomic headwinds. While India’s $676 billion foreign reserves and accommodative monetary policy provide a cushion, the conflict’s economic costs—$1 billion daily for defense alone—highlight the fragility of the situation.

Investors should monitor two critical indicators:
1. Rupee Volatility: A sustained breach of 85.00 against the dollar may trigger RBI intervention.
2. Geopolitical Signals: Any de-escalation talks or ceasefire agreements could reverse the downward pressure.

In the absence of a resolution, the RBI’s balancing act—between growth support and currency stability—will determine India’s economic resilience in 2025. As history shows, prolonged conflict rarely ends well for economies. The rupee’s fate now rests on diplomacy as much as on central bank policy.