Let the rupee move freely: RBI intervention risks more harm than good

Business Standard April 21, 2026

The Indian rupee has been under intense scrutiny in recent weeks, with its depreciation against the US dollar attracting widespread attention. Much of the commentary has framed this decline as a sign of weakness, often applauding the central bank’s efforts to resist it. But this view overlooks a basic point: The exchange rate is a price. And like any price, it must adjust to shifts in demand and supply. Trying to hold it at an artificial level does not fix underlying imbalances — it only postpones the adjustment and risks making the eventual correction more disruptive.

Consider a familiar example. When the monsoon fails, the supply of vegetables falls short of demand. Prices rise, and this serves a purpose: Households cut back consumption, and farmers are encouraged to bring as much produce as possible to the market. The imbalance begins to correct itself.

Now imagine the government steps in to prevent prices from rising. The gap between demand and supply does not disappear—it simply persists. To manage it, the government would then have to impose restrictions, such as rationing or limits on sales. In the end, consumers would face shortages and reduced access, defeating the very purpose of the intervention. This is precisely why governments typically allow such prices to adjust rather than trying to control them.

The same logic applies to the foreign exchange market. When demand for dollars exceeds supply, the price of the dollar rises—and the rupee falls. What we are seeing today is simply this basic market adjustment at work.

So why is demand for dollars rising faster than supply? There are two main reasons.

First, India has been running a current account deficit, which was around $40 billion in 2025-26, but foreign capital inflows were insufficient to finance it. This imbalance helps explain why the rupee was already under pressure last year.

Second, the war in West Asia has made matters worse. By pushing up the prices of key imports, it is likely to widen the current account deficit further—potentially to around $80 billion this year.

As a result, India faces a difficult challenge: It needs to attract around $80 billion in foreign capital at a time when global investors are becoming more risk-averse and pulling money out of emerging markets into safer developed economies. In such a situation, the most practical way to restore balance is to allow the rupee to depreciate.

How does depreciation help? In much the same way that higher vegetable prices restore balance—by reducing demand and encouraging supply. The exchange rate works through two key channels.

First, a weaker rupee helps restore balance through trade. As it depreciates, Indian goods become cheaper for foreign buyers, boosting exports and bringing in more dollars. At the same time, imports become more expensive, which reduces domestic demand for foreign goods. Together, these effects help narrow the current account deficit.

Second, a weaker rupee makes Indian financial assets cheaper for foreign investors. In dollar terms, Indian stocks and bonds now cost less, which can make them more attractive. This can encourage foreign investment into Indian markets, bringing in dollars and helping to finance the current account deficit.

In contrast, if policymakers try to hold the exchange rate at an artificial level, the underlying imbalance does not disappear—it lingers, and can even intensify over time.

The main reason is that the market is aware of the $80 billion funding gap—and that the central bank cannot finance it indefinitely by selling dollars, since it will eventually run out of reserves. Unless this gap is expected to close on its own, some depreciation of the rupee becomes inevitable. Faced with this prospect, firms and households will naturally look for ways to safeguard their wealth, including shifting part of it abroad.

There is another concern. When the central bank tries to manage the exchange rate, the private sector shifts its focus from market signals to guessing the central bank’s next move. This uncertainty can itself be destabilising. If the currency is supported through restrictions—such as the recent curbs on gold and silver imports—it can unsettle the private sector and raise fears of further controls. Such fears can trigger precautionary behaviour, with firms and households pre-emptively moving money out of the country, adding to the pressure on the rupee.

In other words, attempts by the central bank to hold back the rupee risk doing more harm than good — by eroding confidence, fuelling uncertainty, and distorting market signals. This can widen the gap between dollar demand and supply, discourage investment, and complicate economic recovery. The exchange rate is not the problem; it is the mechanism through which the problem is corrected. Holding it back only delays the adjustment and makes the eventual cost higher.

In these circumstances, the most effective policy is also the simplest: Allow the rupee to move freely and do its job as the economy’s primary shock absorber.

From scale to depth: Dismantling frictions within India’s financial inclusion juggernaut

From scale to depth: Dismantling frictions within India’s financial inclusion juggernaut, Ideas for India, April 20, 2026.

RBI’s rupee defence may backfire

Business Standard April 14, 2026

Since the onset of the West Asia conflict, the Indian rupee has come under sustained pressure against the dollar. In response, the Reserve Bank of India (RBI) has stepped up its defence of the currency. However, the measures announced by it risk backfiring, disrupting the foreign exchange market, and intensifying the very pressures they seek to contain, with broader consequences for the economy.

When the war broke out in late February 2026, the RBI, backed by foreign exchange reserves of nearly $730 billion, intervened aggressively. It sold over $30 billion in the spot market in March alone and built up a large short dollar position in the forward market. Despite these efforts, the rupee continued to weaken.

In late March, the RBI shifted strategy. It imposed regulatory restrictions —barring banks from taking positions in the offshore non-deliverable forward (NDF) market and capping their daily onshore FX exposure to $100 million each. These measures appeared to have some immediate effect, with the rupee stabilising briefly. But the key question is whether this strategy can hold.

There are strong reasons to doubt it.

The first concern is the sweeping and abrupt nature of the measures. The RBI did not merely restrict new positions; it required banks to unwind existing ones, reportedly at a cost of ₹4,000–5,000 crore. In effect, banks were penalised for actions that were fully legitimate at the time. Such retrospective costs risk undermining confidence and making banks more cautious in FX markets. Lower participation could reduce liquidity. And when liquidity dries up, currencies tend to become more volatile, not less.

This is particularly troubling because the activity being curtailed was neither illegal nor questionable. Much of it was simple arbitrage — buying dollars in the onshore market and selling them offshore and keeping exchange rates in the two markets aligned. These trades were perfectly normal and had been explicitly permitted by the RBI itself.

Indeed, for several years the RBI had encouraged offshore trading in the rupee as part of a broader push to internationalise the currency. A large offshore market has developed in centres such as Singapore, London, and Dubai, with an estimated $70 billion in daily turnover. By suddenly barring Indian banks from participating in this market, the RBI has reversed its earlier stance. While the central bank has described the move as temporary, such an abrupt policy shift raises concerns about consistency.

To the market, these measures send an uncomfortable signal — that the situation may be more serious than the RBI’s reserves alone can handle. Instead of reassuring investors, this risks eroding confidence. The opposite of what the intervention was meant to achieve.

There is also a broader concern. Banning legitimate market activity raises questions about what might come next. Investors may begin to worry about further restrictions — such as limits on outward remittances — and respond by moving funds out pre-emptively. Foreign investors may become wary of bringing capital into India if there is a risk that exit routes could later be constrained. If such fears take hold, the RBI’s actions could end up triggering the very capital outflows it is trying to prevent.

At the same time, these measures risk impairing the functioning of the FX market itself. In periods of heightened volatility such as the present, firms need to hedge their currency risk. By capping banks’ FX positions and limiting their participation, these measures are likely to raise hedging costs. Early reports suggest this is already happening. As Indian banks step back, hedging has become more expensive — precisely when foreign portfolio investors need certainty on exchange rates before committing capital. This makes India a less attractive destination for investment at a time when capital inflows are crucial.

This brings us to the fundamental problem: The pressure on the rupee is not merely cyclical but structural.

For some time now, capital inflows into India have not been sufficient to finance even a modest current account deficit of around 1 per cent of gross domestic product (GDP). This imbalance helps explain why the rupee was already among Asia’s weakest currencies in 2025, even before the war.

The West Asia conflict has only worsened this situation. Higher global oil and gas prices are widening the current account deficit, reflecting India’s heavy dependence on energy imports. At the same time, capital inflows are weakening due to global risk aversion and a decline in investor appetite for Indian assets. In such circumstances, some depreciation of the rupee is not only inevitable but necessary to restore external balance.

Against this backdrop, it is unclear what the RBI’s measures can realistically achieve. At best, they may delay the needed adjustment. At worst, they could exacerbate underlying pressures by undermining confidence and discouraging capital inflows.

The costs are already being felt beyond the FX market. Uncertainty around the FX strategy has pushed up market interest rates, amplifying the growth-dampening effects of the energy shock.

Perhaps the restrictions will be rolled back in due course. But even then, restoring confidence will take much longer.