As the currency hit new lows during the Iran war, the Reserve Bank of India compelled local banks to unwind bearish bets across both onshore and offshore markets. The absence of an immediate explanation rattled lenders and investors, leaving them uncertain about the central bank’s intent and raising concerns over its risk management approach, according to bankers who requested anonymity due to client sensitivities.
Following the curbs, the rupee rebounded by more than 2% to 92.59 per dollar as of Friday. However, the recovery has come at a significant cost. Banks now face potential losses running into hundreds of millions of dollars, according to Jefferies Financial Group Inc. Hedging costs have surged, complicating investors’ ability to secure protection, while foreign investors have sharply reduced their bond holdings.
The tightening controls and sudden announcement have fueled perceptions that India may be retreating from its efforts to integrate with global markets. These reforms, introduced after the 2013 taper tantrum triggered by the Federal Reserve’s plan to scale back bond purchases, had expanded market access and strengthened India’s appeal. They also paved the way for the country’s inclusion in JPMorgan Chase & Co.’s bond index in 2024.
The rupee market had since expanded globally, gaining traction in financial hubs such as London and Singapore, where it is now more widely traded than within India itself. However, the scale of intervention and lack of clear signaling have raised concerns about policy predictability and transparency. Sanjay Guglani, chief investment officer at Singapore-based Silverdale Capital Pte Ltd., described the RBI’s actions as discretionary and warned that they raise the bar for rupee assets among offshore investors.
The measures began in late March when the RBI capped banks’ daily currency positions in local markets at 0 million by April 10, triggering a scramble to unwind at least billion in arbitrage trades. When the rupee’s slide persisted, the central bank extended restrictions to offshore derivatives, barring lenders from offering non-deliverable forwards, which allow investors to bet on the currency without holding it.
These steps formed a coordinated effort to eliminate bearish positions and speculative trades across markets. Officials targeted investors using non-deliverable forwards to build short rupee positions, along with banks exploiting arbitrage opportunities by buying dollars onshore and selling offshore.
Economists at BofA Securities Inc., led by Rahul Bajoria, warned that the measures risk reversing a decade of liberalization designed to prevent a repeat of the 2013 crisis. They stated that the steps effectively break the link the RBI had cultivated over the past decade.
Global precedents highlight the risks. China’s 2015–17 squeeze on offshore yuan liquidity stabilized its currency but caused funding spikes and unsettled investors. Malaysia’s 2016 clampdown on offshore ringgit trading curbed speculation but drained liquidity. Both cases carried reputational costs, underscoring the delicate balance India must maintain.
Market participants are now reassessing operational risks. Two senior foreign bankers said clients have questioned the RBI’s seemingly arbitrary actions and asked why speculative positions were allowed to build if they posed such systemic risks. Some foreign investors may remain cautious even after current uncertainties subside.
A senior executive at a European bank noted that returning to the non-deliverable forward market could prove difficult even after restrictions are lifted, citing heightened perceptions of regulatory risk. Participation, he warned, may take years to recover.
The immediate impact has been sharp. Offshore 12-month forward points, a key measure of hedging costs, have risen to their highest level since 2013, while onshore costs have reached levels last seen in 2022. Foreign investors have reduced nearly $1 billion from their holdings of index-eligible bonds.
Prashant Singh, senior portfolio manager for emerging-market debt at Neuberger Berman Group LLC, said that while India’s onshore yields are becoming more attractive, recent regulatory measures and global uncertainties have increased hedging costs and complicated investment decisions. He added that the firm prefers to remain on the sidelines until clarity improves.
Jefferies estimates that banks could incur losses of up to ₹5,000 crore ($539 million) due to forced unwinding. Bloomberg News previously reported that State Bank of India held approximately $5 billion in such positions and anticipates losses of around $32 million.
The RBI’s urgency reflects a deteriorating external environment marked by higher US tariffs and rising energy prices following the Iran war, posing challenges for an oil-importing economy with a persistent current-account deficit. Elevated crude prices have increased import costs, while a global flight to safety has strengthened the dollar. A two-week US-Iran ceasefire may provide temporary relief.
RBI Governor Sanjay Malhotra stated that the central bank remains committed to deepening currency markets and internationalizing the rupee. In his first public remarks since the measures were introduced, he emphasized that the steps are temporary and do not signal a shift in policy direction.
The Finance Ministry has also consulted external experts for strategies to stabilize the rupee, reflecting concerns that foreign institutional investors may retreat if depreciation risks intensify. An official response from the ministry was not immediately available, and the RBI has yet to comment on investor concerns regarding regulatory risk.
Authorities have historically approached offshore currency markets with caution, given their role in amplifying pressure during the 2013 taper tantrum. In 2020, the RBI allowed local banks to trade the rupee in global financial centers and later permitted such contracts for domestic clients. However, the latest measures represent the most stringent intervention to date.
The central bank itself has engaged in offshore markets, with its forward book expanding to $78 billion in dollar liabilities as of February. These positions will eventually require settlement, potentially increasing demand for dollars and exerting additional pressure on the currency.
While the current measures do not restrict foreign investors from hedging through domestic banks in deliverable markets, they do not prevent offshore trading of non-deliverable forwards by other participants.
Soumya Kanti Ghosh, chief economic adviser at State Bank of India and a member of the prime minister’s economic advisory council, warned that the measures could create a divergence between onshore and offshore markets, potentially leading to a self-reinforcing cycle of rising offshore premiums.
Recent regulatory interventions have consistently aimed to curb market excesses as India seeks greater global integration. These include tighter rules on equity derivatives and restrictions on the onshore currency futures market in 2024.
Despite these efforts, analysts caution that the trade-off between currency stability and market openness may be unavoidable during periods of stress. Malhotra acknowledged that foreign exchange volatility surged in late March, with growing positions and widening arbitrage between deliverable and non-deliverable markets.
Former Securities and Exchange Board of India board member Ananth Narayan noted that while some rupee positions were for hedging, others were likely speculative. He said excessive one-sided positioning can destabilize markets, making the RBI’s intervention understandable, though the timing remains debatable.
Analysts also warn that structural pressures persist. High oil prices could worsen inflation and the current-account deficit, accelerating the rupee’s decline. Rajeswari Sengupta, associate professor at the Indira Gandhi Institute of Development Research in Mumbai, stated that currency pressures are unlikely to ease quickly given ongoing geopolitical tensions.
The effectiveness of the policy depends on the nature of speculative activity. Jayanth R. Varma, former member of the RBI Monetary Policy Committee, said momentum-driven trades may unwind, aiding stabilization. However, if positions reflect deeper concerns about economic fundamentals, investors may absorb losses and maintain their stance.
For now, the curbs on non-deliverable forwards have reduced liquidity and increased hedging challenges. The widening gap between onshore and offshore markets is already dampening foreign demand for Indian bonds and may further weaken capital inflows.
Rajeev De Mello, global macro portfolio manager at Gama Asset Management SA, emphasized that foreign investors require a reliable and predictable framework to sustain or expand their exposure to India.
The unfolding developments underscore a critical juncture for India’s financial markets, where the balance between defending the currency and maintaining investor confidence will shape the trajectory of capital flows and economic stability.
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