The Reserve Bank of India (RBI) has decided to keep its policy rate at 5.25%. This follows a total cut of 125 basis points in 2025. This choice meets market expectations, indicating the end of the easing cycle while maintaining a neutral position. Governor Malhotra stated that rates are likely to stay the same for the next 9 to 12 months, despite some speculation about future increases. The Indian Rupee is struggling against other emerging market currencies. This situation stems from the RBI’s decision to keep rates steady, along with the assertion that the real interest rate remains relatively high.

Recent Trade Agreement Between the US and India

A new trade agreement between the US and India might affect the USD/INR exchange rate, possibly reversing the gains observed during trade tensions in August. During that time, the US imposed a 50% duty on Indian goods, escalating the trade conflict. The trade deal could help stabilize the currency pair, easing some of the previous tensions. Looking back to 2025, the RBI’s decision to hold rates steady at 5.25% was a clear dovish shift. However, the economic landscape has changed significantly since then, making that guidance difficult to uphold. Recent data shows that India’s CPI inflation increased to 6.5% in January 2026, surpassing the RBI’s 6% tolerance level and complicating the previous neutral stance. The optimism from the US-India trade deal last year only offered temporary relief for the rupee. While the USD/INR rate dropped from its 2025 peaks, it has since risen to about 84.75 as overall dollar strength and domestic inflation concerns reemerge. This trend is driven by a widening interest rate gap, with the US Federal Reserve maintaining its rates.

Rise in Implied Volatility for USD INR Options

In this context, there is an increase in implied volatility for USD/INR options ahead of the next RBI meeting. Traders should prepare for a potential hawkish shift from the central bank, something that seemed unlikely last year. Strategies such as buying call options or call spreads on USD/INR could help guard against further depreciation of the rupee if the RBI surprises the market by not raising rates. The market is now factoring in a policy change, with overnight index swaps indicating at least 50 basis points of potential rate hikes by mid-2026. This is a sharp contrast to Governor Malhotra’s dovish remarks from 2025, creating a possible clash between past guidance and current data. Even a small rate hike could lead to significant fluctuations in the currency as the market adjusts to the end of the steady-rate policy. Create your live VT Markets account and start trading now.

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