Rupee closes at 96.42, a two-month low, before the RBI decision

The rupee closed at 96.42 on Tuesday, its weakest finish in more than two months, as traders waited for the Reserve Bank of India's rate decision on Wednesday.

Reuters reported the currency down 0.1 percent on the day. Dollar sales from state-run banks, which dealers read as action for the RBI, limited the fall. The central bank also appeared to run dollar-rupee sell/buy swaps, a tool it has used in recent weeks, along with open-market bond sales and reverse repo operations, to take cash out of the banking system before the policy meeting.

The Monetary Policy Committee has been in session since 5 October. Governor Sanjay Malhotra is due to announce the decision on Wednesday. About 60 percent of 61 economists in a Reuters poll expect a 25 basis point rise. Swap markets have priced a smaller chance of 50 basis points. A quarter-point move would take the repo rate from 5.25 percent to 5.50 percent, the first increase since February 2023.

J.P. Morgan's analysts wrote that a 25 basis point rise, hawkish guidance, tactical open-market sales and sell/buy swaps would give the rupee some near-term cover and let the pace of tightening follow domestic growth and inflation rather than the currency alone. That is a prescription, not a forecast of what the committee will do. The poll is the closer measure: 60 percent of the panel on 25 basis points, the rest split.

The rupee's last trip through 96 was in July, when it printed 96.10 intraday and closed at 95.94. Tuesday's close at 96.42 is past that finish, if not a new intraday extreme on the numbers Reuters published. Equity outflows were the pressure the report named. Foreign selling has been a feature of the last two months, and a weaker rupee raises the cost of that exit for the buyer of dollars.

A rate rise would, in the ordinary account, support the currency by widening the gap with dollar yields. The last two months have tested that account. US long-term yields have been at levels not seen since the early 2000s, and the dollar has been firm against the euro. A 25 basis point move in Mumbai does not close a gap of that size. It does tell the market that the committee is willing to use the policy rate, which it has not done since February 2023.

The swaps matter because they are how the RBI can sell dollars without permanently cutting its reserves. A sell/buy swap sells dollars now and buys them back later. The rupee liquidity that the sale creates is then drained. Dealers said that is what the state-run banks were doing into the close. If they are right, the 96.42 finish is a managed number, not a free one. The RBI does not confirm those operations on the day.

Wednesday's statement will be read for three lines: the rate, the stance, and any sentence on the currency. A hike with no comment on the rupee would leave the swaps to do the work. A hike with a line on external stability would put the committee on the record. A hold would surprise the 60 percent and push the next test onto the spot market on Wednesday afternoon.

The close at 96.42 is the number the policy has to answer. It is the weakest finish in more than two months, and it arrived on the eve of the first rate decision since the committee last raised.

Equity dealers have a second clock running. The Sensex closed Tuesday at 73,067.81, up 685 points, and the Nifty at 22,776.10. Banks led. A currency at a two-month low and a stock index up almost 1 percent is a split market. Foreign sellers can be leaving the currency even as local buyers lift banks into a policy day. Wednesday will tell which of those flows lasts. A hike that matches the poll can support both. A hike of 50 basis points, the smaller chance priced in swaps, would be read first in the bond market and then in the rupee.

The 96.42 close is also a level importers will use on Wednesday morning. A firm that has to pay for a cargo prices the dollar at the open, not at the RBI's press conference. If the state-run banks are back in the market before Malhotra speaks, the open may not hold 96.42. If they are not, the level is the one the committee inherits.