The Reserve Bank of India (RBI) Wednesday said it would ensure that the "undervalued" rupee finds its correct level even as the currency slipped to a five- month low of 96.8450 a dollar.

The currency isn’t far from its all-time low of 96.96 to a dollar – hit on May 20 – having lost 7% so far this year. The currency ended at 96.7750, 0.4% down as against the previous close of 96.42.

The central bank, which bumped up both FY27 inflation and growth projections, raised the policy rate 25 basis points Wednesday in the first such hardening since February 2023.

Governor Sanjay Malhotra said that rupee is undervalued in terms of real effective exchange rate and that the market could be irrational in the short run.

"We will ensure the rupee stabilises and finds its correct value. We will support the rupee's orderly movement," Malhotra said at the post-policy media interaction, reacting to the rupee's intra-day fall to 96.85.

While higher interest rates generally strengthen a country's currency because they offer better returns to overseas investors, persistent outflows of foreign capital from Indian markets kept the rupee under pressure.

"It's likely to be a factor of stronger dollar index and withdrawal of debt and equity investments by foreign investors," Bank of Baroda chief economist Madan Sabnavis said.

Traders said that the central bank intervened in the forex market to cap the fall.

RBI has likely conducted dollar-rupee sell-buy swaps to absorb surplus liquidity from the inter-bank market, pushing the one-year forward up to 3.82%, its highest in six months. The three-month forward premium rose to 4.95% while the 6-month premium rose to 4.4%.

"Corporates were seen buying forward in panic," forex market consultant KN Dey said. "It's also rare for the rupee to sharply weaken on a day when the RBI tightens policy rate," he added.