RBI's Aggressive Rupee Defense Risks Alienating Global Investors, Analysts Warn
The Reserve Bank of India's most assertive push in nearly a decade to stem the rupee's decline may inadvertently act as a deterrent for the very global investors that Indian markets have strived to attract. With the currency sliding to fresh lows amid the Iran conflict, the central bank directed domestic banks to unwind bearish positions in both onshore and offshore markets. However, this move was executed without immediate clarification, unsettling lenders and investors who were left uncertain about the RBI's intentions and concerned about its risk management approach, according to bankers familiar with the matter quoted in a Bloomberg report.
Rupee Recovery Comes with Significant Side Effects
Following these restrictions, the rupee has rebounded more than 2 percent to 92.66 against the dollar as of Thursday. This recovery, though, has arrived with substantial side effects. Banks could face losses amounting to hundreds of millions of dollars, as estimated by Jefferies Financial Group Inc. Simultaneously, hedging has become more expensive, complicating efforts by investors to protect their positions, while foreign investors have reduced their exposure to Indian bonds.
The sudden nature of these measures and tighter controls risk creating an impression that India may be stepping back from its efforts to deepen integration with global financial markets. Those reforms, rolled out after the 2013 taper tantrum when the Federal Reserve's plans to reduce bond purchases triggered capital outflows from emerging markets, had strengthened India's attractiveness and eventually led to its inclusion in JPMorgan Chase & Co.'s bond index in 2024.
Scale of Intervention Raises Transparency Concerns
Over the years, the rupee market has broadened significantly, with the currency gaining traction in major financial centers such as London and Singapore, where it is now traded more actively than within India itself. The scale of the RBI's intervention and the absence of clear communication have raised serious concerns over policy consistency and transparency, said Sanjay Guglani, chief investment officer at Singapore-based Silverdale Capital Pte Ltd., which manages approximately $1.5 billion.
He characterized the RBI's actions as discretionary, noting that "this raises the bar for rupee assets among offshore investors." The steps were set in motion in late March, when the RBI imposed a cap on banks' daily currency positions in the domestic market at $100 million, to be enforced by April 10. This triggered a rush to unwind roughly $30 billion worth of arbitrage trades.
Coordinated Effort to Eliminate Bearish Bets
As the rupee continued to weaken despite these initial actions, the central bank soon widened the restrictions to offshore derivatives. It barred lenders from offering non-deliverable forwards, instruments that allow investors to take positions on the currency without actually holding it. Taken together, these measures represent a coordinated effort to eliminate bearish bets on the rupee and curb speculative activity across markets.
The focus was specifically on investors using NDFs to build short positions on the rupee, as well as banks engaged in arbitrage strategies that involved buying dollars domestically and selling them offshore to exploit pricing differences. Both sets of activities had contributed significantly to the downward pressure on the currency.
Risk of Undoing Years of Liberalization
Economists at BofA Securities Inc. cautioned that such actions could undo years of liberalization aimed at preventing a repeat of the 2013 episode. In a note led by Rahul Bajoria, they stated that the steps "essentially break the link RBI had cultivated in the last decade." Experiences from other countries highlight the inherent risks. China's tightening of offshore yuan liquidity between 2015 and 2017 helped steady the currency but led to funding pressures and unsettled global investors.
Similarly, Malaysia's 2016 restrictions on offshore ringgit trading reduced speculative activity but drained liquidity. In both instances, the measures came with reputational consequences, illustrating the delicate balance that India needs to maintain.
Challenging External Environment
The RBI's swift action comes against a weakening external environment marked by higher US tariffs and a surge in energy prices following the Iran conflict, a challenging combination for an oil-importing country with a persistent current account deficit. Elevated crude prices have pushed up the import bill, while a global shift toward safe-haven assets has strengthened the dollar. A temporary two-week ceasefire between the US and Iran could provide some respite.
RBI Governor Sanjay Malhotra said on Wednesday that the central bank continues to focus on developing currency markets and advancing the internationalization of the rupee, adding that the recent measures should not be interpreted as a change in policy direction. In his first public comments after the steps were announced, he emphasized that the measures are temporary and will not be permanent.
Government Outreach and Market Divergence
According to a person familiar with the matter, the Finance Ministry has consulted external experts for suggestions to stabilize the rupee. This outreach reflects concerns within the government that foreign institutional investors may remain cautious if depreciation risks persist. The latest steps do not bar foreign investors from hedging through domestic banks, provided such transactions take place in the deliverable market and are not speculative in nature. Nor do they prevent other participants from engaging in offshore NDF trading.
Soumya Kanti Ghosh, chief economic adviser at State Bank of India and a member of the prime minister's economic advisory council, stated "such measures are likely to create a wedge between offshore and onshore markets." He added that this divergence "might create a vicious loop," where offshore premiums continue to rise.
Limited Support Amid Economic Pressures
Some analysts believe the central bank's actions may provide only limited support to an economy dealing with a current account deficit and capital outflows. Elevated oil prices could further strain inflation and widen the deficit, adding to pressure on the rupee. For now, restrictions on the NDF market have reduced liquidity and made hedging more challenging. The growing divergence between offshore and onshore markets is already affecting foreign appetite for Indian bonds and could weigh on future inflows.
Rajeev De Mello, global macro portfolio manager at Gama Asset Management SA, emphasized: "Foreign investors need a reliable and predictable investment framework to maintain or increase their portfolio allocations to India." The RBI's aggressive defense of the rupee, while aimed at stability, thus walks a fine line between short-term currency management and long-term investor confidence.
