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Informist, Thursday, Apr. 23, 2026

 

By Aaryan Khanna and Pratiksha

 

NEW DELHI – The rupee has slipped 1% over the past three days after the Reserve Bank of India rolled back some of its curbs on banks' trading in the non-deliverable forwards market for the domestic currency, necessitating intervention in the dollar-rupee spot market. With the uncertainty related to the war in West Asia continuing, market participants now want the central bank and the government to take measures that will prevent the rupee's depreciation becoming a self-fulfilling prophecy. They say the most effective booster for the rupee would be foreign inflows into Indian markets.

 

Foreign inflows have practically dried up over the past two years. In this period, India has failed to attract substantial foreign capital or portfolio investments despite being the world's fastest growing major economy. In FY25, net foreign direct investment into the country was near an all-time low of less than $1 billion, according to RBI data. This rose to $1.66 billion in the first 10 months of FY26, hardly an improvement.

 

Depository data show foreign portfolio investors pulled out nearly $3 billion on a net basis in the 11 months to February, then dumped over $15 billion in March alone after war broke out in West Asia. This in effect means the RBI has had to fund the current account deficit on its own, which in FY26 was expected to be around $40 billion, or 1% of GDP.

 

The rupee fell more than 6% against the dollar in Apr-Feb at a time when the dollar index also weakened by over 6?fore the US and Israel attacked Iran on Feb. 28. With the sharp rise in the price of crude oil and of other inputs in an import-dependent economy, the International Monetary Fund projects India's current account deficit to balloon to 2% of GDP in FY27 from 0.9% in the previous year. Though this is still eminently fundable, foreign exchange market participants do not want only Band-Aids from the regulator but a path to sustained inflows at a time when foreign investors are likely to give emerging markets like India a miss. Of course, boosting inflows remains more an item on the government policy agenda than a task for the central bank.

 

"The RBI needs to do more in terms of the external sector. By effectively keeping two interest rate regimes through domestic liquidity and the FX (foreign exchange) market, the strain on the CAD is expected to continue every time a geopolitical risk rears its head," Ashhish Vaidya, managing director and country treasurer at DBS Bank India, said.

 

One criticism has been that the cost of hedging against the depreciation of the rupee has been very high for investors and this has incentivised even domestic investors to park funds in dollars offshore. India's overnight secured money market benchmark--the Secured Overnight Rupee Rate--has a spread of only around 125 basis points over the Secured Overnight Financing Rate, the benchmark for overnight dollar funds. In comparison, the one-month dollar-rupee forward rate had risen to nearly 7?rlier this month. The cost of hedging a rupee exposure for three years, a standard contract for FDI, has been over 8.5% for the past few months, spiking during the military conflict in West Asia before cooling slightly when active warfare ceased, dealers said.

 

The fix, traders say, is the classic interest rate defence of the currency to incentivise investment in India by both onshore participants and offshore investors. Instead of keeping domestic money market rates low, the central bank should drive up rates on short-term fixed income instruments, they say. The State Bank of India even suggested Operation Twist--liquidity-neutral sales of short-term bonds counteracted by simultaneous purchases of longer-term gilts. Others expect more conventional measures such as tightening rupee liquidity to drive up short-term rates, which will both curb speculation and attract capital.

 

The regulator could also more actively dissuade net outward flows of dollars from the domestic economy, participants said. Investments from companies in overseas joint ventures and subsidiaries have totalled over $45 billion in both FY25 and FY26. On the other hand, external commercial borrowings by companies slumped to $37 billion in Apr-Feb from $50 billion a year ago. This implies a net outflow of capital from the corporate sector and not just from foreign investors.

 

Some market participants batted for the RBI providing a window for foreign currency non-resident deposits at attractive rates, a measure last used 13 years ago. Other measures from the "taper tantrum" era have already made their appearance, including trading limits and a special window for oil importers to have their dollar needs met directly from the RBI and large state-owned banks. The next steps that followed during the 2013 crisis included tighter liquidity and, finally, rate changes.

 

"The RBI had correctly taken steps to immediately halt the rupee's fall because as the regulator, you need to curb impact of positions undertaken by speculators betting against the rupee," Kanika Pasricha, chief economic adviser at Union Bank of India, said. "We are at the first stage of the 2013 playbook. Other than these measures, the RBI and SEBI (Securities and Exchange Board of India) can also increase the scrutiny of IPO (initial public offering) documents to gauge the drivers of spike in outward FDI seen in position exit taken by promoters. Restriction of drop in durable FDI flows is key to fundamentally support the rupee."

 

To lure foreign investors back to India, a primary requisite is to give them more confidence on the exchange rate. After the recent unexpected and drastic regulatory measures on the non-deliverable forward market, confidence in the stability of the exchange rate has only deteriorated and the central bank should be working to rebuild that, market participants said. Without action from the regulator or the government, the rupee is likely to continue sliding even with the currently healthy foreign exchange reserves being used in a stop-gap defence, they said.

 

RBI Governor Sanjay Malhotra earlier this month said he is hopeful of good inflows from foreign investors in the debt market in FY27 and lower outflows from them from the equity market, adding that India's fundamentals and demographics are strong and the country also offers macroeconomic stability. RBI Deputy Governor Poonam Gupta said remittances are expected to pick up in FY27 as demand for Indian workers in West Asia will rise as part of the rebuilding process following the war. Traders, however, see such an assessment as too rosy.

 

"RBI seems to have this false idea that just strong fundamentals will help us get flows," a treasury head at a private-sector bank said. "That's not how it works. You have to do something to make the capital market attractive for investors, they won't come on their own."

 

An outright push from the government's side could be to lower taxes and even give tax holidays to certain types of foreign investors for a limited period, until the geopolitical uncertainty blows over, traders said. In equities, FPI sentiment has soured since the short-term capital gains tax was hiked to 20% from 15% and long-term capital gains tax was raised to 12.5% from 10% in July 2024. Active debt inflows have been stymied by the withholding tax imposed on coupon payments, which foreign investors have protested against for a long time.

 

"Given the urgency of the matter, tax break for FPIs seems like the most feasible thing to do to solve things quickly," the treasury head said.

 

Some commentators, including former SEBI whole-time member and former top trader Ananth Narayan G., have also suggested a rebalancing of tax incentives between equity and debt. Returns from debt investments are taxed as part of the investor's income with 30?ing the maximum rate while the long-term capital gains tax on equities is only 12.5%. This has driven domestic savings towards the stock market, keeping valuations frothy even after record FPI sales. A rebalancing of domestic portfolios can lead to a correction in equities and bring in the much-needed revival of foreign inflows, market participants said.

 

As the market discusses what carrots the RBI and the government may offer and the sticks they may wield, traders are not convinced that the scale of the problem is apparent to those in charge. They worry that necessary but unpalatable measures will not be implemented because of the short-term pain they will cause. The warning from the market is that if the RBI doesn't make use of the crisis, foreign investors may well pass India by as an investment destination and a lot of opportunity may never be fulfilled.

 

"The Cabinet secretary was the finance secretary when the current tax regime was set up. The RBI governor was the revenue secretary," a treasury head at another private-sector bank said. "If the tax rates have to be rationalised, there is no doubt that (equity) markets will fall and people will lose money on their SIPs (systematic investment plans). I doubt they (the government) will be willing to take that bitter pill."  End

 

US$1 = INR 94.10

 

Edited by Rajeev Pai

 

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