Envisioning the INR as a floating exchange rate

by Rounak Hande, Rajeswari Sengupta and Ajay Shah.

The Question

A central question in macroeconomic policy is the exchange rate regime. In the long-run, India’s economic strategy should move to a combination of inflation targeting, floating exchange rate and an open capital account. In more than three decades since the economic reforms of 1991, only one of these milestones has been achieved–RBI today is an inflation targeting central bank. For IT to be fully effective, it must be accompanied by a floating exchange rate. However, we in India are used to the idea that the RBI actively intervenes in the FX market to stabilise the USD/INR rate. It is important to ask, What might a genuine floating exchange rate look like if the RBI did not intervene? In other words, If RBI were to the USD/INR what SEBI is to the Nifty, what would that world look like?

When it comes to government price controls on commodities, e.g. wheat, there is a ready way to visualize what a reformed India would look like: the Indian price of wheat would be the world price of wheat. But what about the exchange rate? If the required reforms took place, and we got to a market determined rupee, what would it be like? In this article, we present a reasonable depiction of what the exchange rate regime would be like, if the RBI did nothing on the currency market. This also helps us understand how much currency volatility Indian firms and households need to prepare for if the RBI were absent from the market.

The period of INR as a float

When we look back into India’s history, we find that there was one period when trading by the RBI on the currency market dropped to near zero levels. We treat this as a natural experiment to gain insights into what the INR would look like without government control. Our first task is to establish the start and end dates of that period.

We start with three long time-series graphs: (i) RBI’s spot market trading volume in USD, (ii) RBI’s spot market trading volume relative to reserve money, and (iii) RBI’s open position on the currency forward market.

Figure 1: The long time-series of spot price trading volume by RBI, in billion USD

Figure 2: The long time-series of spot price trading volume by RBI, expressed as per cent of M0.

Figure 3: The long time-series of the RBI’s currency forward position, in billion USD.

In all these graphs, we can spot one remarkable period, from June 2009 to October 2011, where an important reform of the exchange rate regime took place, and the RBI stepped out of the currency market. Let’s zoom into that period. To obtain greater clarity, we focus on the period from June 2006 to October 2014, adding three years to each side.

Figure 4: Spot price trading volume by RBI, in billion USD (June 2006 to Oct 2014).

Figure 5: Spot price trading volume by RBI, expressed as per cent of M0 (June 2006 to Oct 2014).

Figure 6: RBI’s currency forward position, in billion USD (June 2006 to Oct 2014).

In these pictures, we see a middle period — 28 months from June 2009 to October 2011 — when currency trading by the RBI was very low. The RBI’s trading volume in these months was not always 0. In choosing these endpoints, we set a limit where the RBI’s gross monthly trading volume stayed below 1 percent of M0.

Examining the characteristics of this period gives us insights into what a floating exchange rate in India might look like.

Characteristics of the INR as a float

In this section we describe the characteristics of the INR in the period from June 2009 to October 2011. For the sake of comparison, we use the methodology described in Sengupta and Shah (2026) to establish the dates of two other exchange rate regimes. We will now focus on three such regimes:

• The natural experiment of the INR as a float: 1st June 2009 to 31st October 2011.
• The recent period of a tight USD peg : 1st September 2023 to 16th December 2024.
• The present exchange rate regime: 27th December 2024 to 28th August 2026 (latest available data).

For each of these periods, we examine (a) The volatility of the USD/INR rate (b) The parameter estimates obtained from the exchange rate regression (see Google colab notebook associated with Sengupta and Shah (2026)) and (c) Deviations from market efficiency as seen in variance ratios.

Metric	Float (June 2009–Oct 2011)	The USD peg (Sept 2023–Dec 2024)	Current ERR (Dec 2024–Aug 2026)
Volatility:
USD/INR vol (%)	7.40	1.43	4.98
The exchange rate regression:
USD	0.66***	0.89***	0.79***
EUR	0.20**	0.05	0.11
JPY	-0.15**	-0.01	-0.08
GBP	0.04	0.05	0.25
R-sq	0.75	0.98	0.76
RSE	0.77	0.18	0.67
Variance ratio tests:
VR(5), daily	0.99	0.67	0.96
p value	0.82	0.03	0.61
VR(4), weekly	1.07	0.64	0.76
p value	0.93	0.03	0.14

We summarise our findings as:

• In the popular discourse on the INR, a lot of attention is given to the raw USD/INR volatility. At present, it is running at 4.98 percent. During the period of the USD-peg, it had fallen to 1.43 percent. We see that under the float, it was 7.4 percent. In other words, if the RBI did not intervene in the currency markets, the USD/INR volatility that the economy could experience is around 7-7.5 percent. Later in the article, we speculate on how things might work out if the INR were to return to a float under the present conditions and we argue that the volatility could be lower.

  The numbers also suggest that during the current exchange rate regime (27th December 2024 to 28th August 2026), the machinery of the RBI’s currency policy seems to have delivered only a small decline in volatility of about 2.4 percentage points on an annualised basis.

• In the exchange rate regression, during the period of the USD peg, the USD coefficient was statistically significant with a value of 0.89, and no other currency was significant. At present, the USD coefficient has come down to 0.79, but still, none of the other currencies have statistically significant coefficients.

  In contrast, during the period of INR float, the USD coefficient was smaller at 0.66, and other currencies were significant too. This suggests that the Indian economic engagement with the outside world is not merely with the US. In the float period, USD, EUR and JPY were all statistically significant, with coefficients of 0.66, 0.2 and -0.15. This gives us an undistorted sense of the currencies that matter for the Indian economy.

• Another important statistic from the exchange rate regression is the residual standard deviation (or RSE, residual standard error). It shows the size of the prediction error of the exchange rate regression. A lower RSE means the model fits the data well. Therefore, during the period of the USD peg, the residual standard deviation was only 0.18. In contrast, under the INR float the RSE was 0.77. In the current regime, the RSE stands at 0.67.

• In the exchange rate regression, during the period of the USD peg, the R-squared was 0.98. A high R-squared value implies that almost all of the variation in the INR was accounted for by the currencies in the regression model. At present, the R-squared has fallen to 0.76. During the INR float, the R-squared had a very similar value, 0.75. In other words, despite active trading by the RBI in the currency market in the present period, there is not much of a difference in the R-squared.

  This yields insights into deciphering a floating exchange rate regime from the data. A floating exchange rate does not necessarily mean an R-squared value close to 0. It means that the central bank does not intervene and lets the exchange rate respond freely to market forces. In a floating regime, the R-squared value can still be high because it reflects the natural, underlying co-movement of the rupee with major currencies of the world (and not just the USD) under conditions of globalisation. India is deeply interconnected with these countries through trade and financial flows, and is exposed to the same global shocks. Some co-movement is therefore entirely consistent with a genuine float.

• The variance ratio test is a simple tool to examine serial correlations. A floating exchange rate is expected to be an efficient market, with no discernible serial correlation, and no exploitable profit opportunities for trading based on time-series characteristics. This does work out correctly in the float period. In the daily data, the 5-period variance ratio was 0.99, and indistinguishable from 1, whereas in the weekly data, the 4-period variance ratio was 1.07 and indistinguishable from 1. Under the USD peg, the two variance ratios were 0.67 and 0.64, with statistically significant deviations from non-forecastability. In the present arrangement, the variance ratio at 4 weeks is away from 1.

A useful variant of the exchange rate regression, introduced in Kumar et. al. (2020), differentiates between the USD coefficient when faced with a USD appreciation vs. a depreciation thereby highlighting asymmetric intervention by the RBI. We now turn to these estimates.

Metric	Float (June 2009–Oct 2011)	The USD peg (Sept 2023–Dec 2024)	Current (Dec 2024–Aug 2026)
USD (App)	0.52***	0.87***	0.68***
USD (Dep)	0.83***	0.91***	0.88***
EUR	0.20***	0.05	0.12
JPY	-0.15***	-0.01	-0.09
GBP	0.04	0.05	0.24
R-sq	0.77	0.98	0.77
RSE	0.74	0.18	0.66

During the period of the USD peg, it is not surprising to see statistically significant values of the USD coefficient close to 1, for both USD appreciation and USD depreciation. This makes sense because when the RBI is pegging the INR to the USD, it is expected that currency interventions would take place on both sides of the market, regardless of which way the USD is moving. In the present exchange rate regime, the INR responds more strongly to a USD depreciation (with a coefficient of 0.88) than it does to a USD appreciation (with a coefficient of 0.68). This implies that the RBI now intervenes asymmetrically, letting the INR move more freely when the USD appreciates (i.e. the INR depreciates) but managing the INR more when the USD depreciates (i.e. the INR appreciates). This is consistent with existing studies documenting the RBI’s asymmetric intervention patterns (Patnaik and Sengupta, 2022). RBI prefers buying dollars (preventing INR appreciation) over losing reserves (preventing INR depreciation).

Interestingly however, we find asymmetric coefficients in the floating period too, with a response of 0.83 when the USD depreciates but a coefficient of 0.52 when it appreciates. This is puzzling because in a float, there should be no asymmetry between these coefficients, both of which should be equally low. Further research is therefore required to understand the market-based sources of this asymmetry.

Conclusion

In the strategic view of macroeconomic policy, the long-run answer for India lies in graduating from one milestone — inflation targeting — to two more milestones — a floating exchange rate and an open capital account.

At every stage in the journey of Indian economic reforms, the prospect of getting the government out of price determination has raised alarms in the minds of some people. When the proposals to remove price controls for steel or cement were made, there was shock and unhappiness in the minds of many people. These things are often easier done than said, because the price system works rather well. It solves the resource allocation problem, and prices move continuously in a way that provides good incentives to private persons.

In this article we have shown one tangible period, of 883 days, in which the RBI stayed away from the currency market and there was a genuine floating exchange rate. This period can be utilised for many other research projects. Using the insights from this period, we are now able to offer a thumb rule to judge the extent of government management of the exchange rate in India in terms of three numbers. For example, we can compare the values observed today of (i) the USD/INR volatility of 4.98 percent, (ii) the USD coefficient of 0.79, and (iii) the RSE of 0.67 vs. the values observed during the float: (i) the USD/INR volatility of 7.4 percent, (ii) the USD coefficient of 0.66, and (iii) the RSE of 0.77. This gives us a sense of how much government control of the exchange rate is present today.

This natural experiment, of a country that graduated to a floating exchange rate and then retreated from it, gives us insights on how to interpret the estimates from the exchange rate regression and the toolchain of Zeileis et. al (2010).

Looking into the future, when economic policy reforms take place in India, we believe the USD/INR volatility under a true floating exchange rate will be lower than this value of 7.4 percent, for two reasons:

1. There is one important difference between the float period of 2009-2011 and the future: Inflation Targeting. That RBI movement to a floating exchange rate was incomplete because it was not accompanied by inflation targeting. In some sense, that was a particularly unfortunate event as the rupee lost its nominal anchor during that period. In the future, things will be better because now the nominal anchor is 4 percent CPI inflation.
2. Another important difference concerns the liquidity of the USD/INR spot and derivatives markets. In the 2009-2011 period of INR float, these markets were less developed. We estimate that in that period, the total turnover(onshore and offshore) was about USD 40 billion per day. By now, things have improved, with a huge increase in INR activity outside India. Now the total turnover (onshore and offshore) is about USD 140 billion per day. This bigger market delivers greater stability. Hence, we can speculate that in the future, things will be better in terms of USD/INR volatility.

References

Kumar, S H, Balasubramaniam, V, Patnaik, I and Shah, A (2020), “Who cares about the Renminbi?“, Working Paper, December 2020.

Patnaik, Ila and Rajeswari Sengupta (2022) “Analyzing India’s Exchange Rate Regime“, India Policy Forum, National Council of Applied Economic Research, vol. 18(1), pages 53-85.

Sengupta, R and Shah, A (2026), “Words and deeds in the Indian exchange rate“, The Leap Blog, May 19, 2026.

Zeileis, A, Shah A, and Patnaik, I (2010) “Testing, monitoring, and dating structural changes in exchange rate regimes“, Computational Statistics & Data Analysis, Volume 54, Issue 6.

Rounak Hande and Ajay Shah are researchers at XKDR Forum, Mumbai and Rajeswari Sengupta is a researcher at IGIDR, Mumbai.

Source: https://blog.theleapjournal.org/2026/09/envisioning-inr-as-floating-exchange.html