As the Reserve Bank of India’s Monetary Policy Committee (MPC) concluded its meeting on June 6, 2025, the central bank delivered a widely watched policy move: a 50 basis point cut in the repo rate, bringing it down to 5.50%. This marks the third consecutive reduction this year, underscoring the RBI’s intent to support economic growth amid a backdrop of subdued inflation and persistent global uncertainties

The importance of repo rate adjustments, therefore, cannot be understated. Any change in the repo rate will not just impact the borrowers and investors, but also foreign capital flows and rupee’s resilience.

In this blog, we’ll look at how the MPC’s decision will send ripples through India’s economic landscape, shaping currency dynamics in a pivotal moment for policy.

Why is Currency Stability Important?

For investors and businesses, a stable rupee means:

• Predictable prices of imports like electronics and oil
• Better control over inflation
• Confidence for both Indian and foreign investors

However, when the rupee falls sharply, it adds pressure on importers, companies repaying overseas debt, and even the Reserve Bank of India (RBI), which may need to draw on its forex reserves to calm the volatility.

Repo Rate Changes and Their Immediate Effect on the Economy

Changes to the repo rate can have profound impacts on various sectors of the economy. These impacts ripple through the entire financial ecosystem, including foreign investment and currency stability. Here’s a breakdown of how repo rate cuts or hikes influence these two areas:

1. Impact on Foreign Investment

Foreign investors are particularly sensitive to repo rate changes as they impact returns on investments. Let's break down the key factors at play:

Interest Rate Differentials and Foreign Capital Flow

A repo rate cut generally signals a more accommodative monetary policy. For foreign investors, a lower repo rate means lower returns on fixed-income instruments like bonds and deposits. In the short term, this might result in a decrease in foreign portfolio investment (FPI) as investors move their capital to other markets with higher yields. Conversely, when the RBI raises the repo rate, the attractiveness of Indian financial assets increases due to higher yields, potentially boosting foreign inflows.

Risk Appetite of Foreign Investors

The repo rate indirectly influences the risk appetite of foreign investors. A lower repo rate can make borrowing cheaper, encouraging businesses to invest in expansion. While this might be beneficial for the long-term economic growth of India, foreign investors may be cautious about increasing their exposure to a market where inflation might rise due to excessive liquidity. This is why monetary policy decisions are carefully scrutinised.

Inflation Expectations

Repo rate cuts typically come with expectations of rising inflation, which could deter foreign investors. Inflation erodes the purchasing power of the local currency, which means real returns for foreign investors may diminish. Therefore, maintaining a balance between inflation control and encouraging investment is crucial when making decisions about repo rate changes.

2. Impact on Currency Stability

India’s currency, the rupee, is highly sensitive to repo rate changes, as these directly influence inflation and investor confidence.

Inflation Control and Currency Depreciation

When the RBI cuts the repo rate, the immediate effect could be an increase in inflation as the cost of borrowing decreases. Higher inflation typically leads to a decline in the value of the local currency. This is because investors anticipate lower purchasing power, making the currency less attractive. Foreign investors, especially those dealing with large sums, may convert their investments into more stable currencies, further exacerbating currency depreciation.

Conversely, a repo rate hike strengthens the currency as it signals that inflation is under control and provides a higher return on investments. The rupee strengthens as demand for the currency increases, bolstering foreign investor confidence and reducing capital outflows.

Foreign Exchange Reserves and Market Sentiment

Repo rate decisions also influence foreign exchange reserves and overall market sentiment. A proactive policy stance can boost investor confidence in the economy, stabilising the currency. However, if there is a perception that the RBI is behind the curve in managing inflation or economic growth, it could trigger capital flight and weaken the currency. A steady and predictable monetary policy approach is crucial for maintaining the stability of the rupee.

3. Monetary Policy Tools Beyond Repo Rate Changes

While the repo rate is the most visible tool, the RBI uses a host of other monetary policy instruments to control inflation and stabilise the economy. These include:

• Reverse Repo Rate: This is the rate at which banks lend money to the RBI, and it complements repo rate adjustments. It helps control short-term liquidity in the system.
• Cash Reserve Ratio (CRR): This is the percentage of a bank’s total deposits that must be maintained as reserves with the RBI. An increase in the CRR can reduce liquidity in the system, indirectly affecting investments and currency values.
• Open Market Operations (OMO): The RBI conducts OMOs to regulate the money supply and control inflation. By buying or selling government bonds, it can influence the liquidity in the economy, impacting both foreign investment and currency stability.

Final Thoughts

While the repo rate may appear to be a technical number for economists and central bankers, its ripple effect extends across industries, borders, and households. By managing this one tool wisely, the RBI doesn’t just shape India’s growth path—it shapes how the world views India.

Understanding this connection empowers us—as investors, consumers, and citizens—to see the bigger picture when policy announcements are made.

FAQs

Does a repo rate cut always weaken the rupee?

Not necessarily. While a repo rate cut can sometimes lead to a depreciation of the rupee due to inflationary concerns and reduced foreign investor interest, other factors, such as global market trends or RBI interventions, can offset this effect. The overall impact depends on the broader economic context.

How does a stable or higher repo rate impact foreign capital inflows?

A stable or higher repo rate signals that the RBI is committed to controlling inflation and maintaining a stable currency, which can attract foreign capital. This is because foreign investors generally prefer countries where inflation is under control, and returns on investments are predictable and relatively higher.

Can changes in foreign investment influence the repo rate?

Yes, significant fluctuations in foreign investment can influence the RBI’s decisions on the repo rate. For example, if capital inflows decrease, the RBI may adjust the repo rate to make the domestic market more attractive to foreign investors. Alternatively, if there is an excess of foreign capital, the RBI may opt to increase the repo rate to avoid excessive liquidity and rising inflation.Yes, significant fluctuations in foreign investment can influence the RBI’s decisions on the repo rate. For example, if capital inflows decrease, the RBI may adjust the repo rate to make the domestic market more attractive to foreign investors. Alternatively, if there is an excess of foreign capital, the RBI may opt to increase the repo rate to avoid excessive liquidity and rising inflation.

What role does the RBI play in balancing foreign investment and currency stability?

The RBI uses the repo rate and other monetary policy tools to strike a balance between encouraging foreign investment and maintaining currency stability. By adjusting the repo rate, the RBI influences inflation, liquidity, and investor sentiment, ensuring that the rupee remains stable while fostering a conducive environment for foreign capital.

How do global interest rate movements affect India’s repo rate and foreign investment?

Global interest rate changes, particularly in major economies like the US, can impact India’s repo rate and foreign investment. If global interest rates rise, India might need to increase its repo rate to maintain competitiveness and attract foreign investment. Alternatively, if global rates are low, India may reduce its repo rate to stimulate domestic growth and maintain foreign investor interest.