RBI’s forex gamble may steady the rupee but weigh on investor sentiment

The cap, introduced on 27 March and followed by tighter curbs on related-party trades on 1 April, is aimed at breaking the link between offshore speculative activity and onshore exchange rate movements.

While the central bank clarified on 20 April that genuine back-to-back hedges, including those between domestic and overseas branches, would not be treated as speculative and allowed existing positions to run until maturity, the tightening’s broader impact is becoming clearer.

The RBI’s approach risks fragmenting an already broken market between onshore and offshore trading, Ajay Marwaha, senior executive and fixed income head for local and offshore for Nuvama Group, said.

He said while the regulator has introduced curbs in the onshore market, the rupee is a currency of growing global interest, and offshore markets continue to operate beyond its direct reach. This divergence could have unintended consequences.

“If overseas investors are unable to manage currency risk onshore, they will naturally shift to offshore markets or even reconsider exposure to India altogether. When flexibility is constrained domestically, the incentive to engage with India reduces,” he added.

Not all market participants agree with Marwaha. “What they (RBI) have done is effectively cut what I would call a vicious loop between the onshore exchange rate and the speculative activity,” Dhiraj Nim, foreign exchange strategist at ANZ, said.

By capping positions at $100 million, RBI has reduced the influence of offshore market views on domestic pricing. This, in turn, has made interventions more effective. “The intervention now would be more fruitful because there is no speculation in the market to contend with,” Nim said.

Curbing speculation

The RBI, on the other hand, appears dissatisfied with market intermediaries such as primary dealers, which it sees as contributing to the large buildup of open positions—estimated at $30–40 billion that prompted the clampdown. RBI governor Sanjay Malhotra cautioned on 1 May that the privileges enjoyed by banks and primary dealers (PDs) come with clear obligations to ensure fairness and market access.

However, this comes with trade-offs. Reduced participation by hedge funds and fast-money players has lowered liquidity and increased hedging costs. “Initially, the market was very liquid, and foreign portfolio investors (FPIs) could hedge at very small cost, and now that cost has gone up. It’s just a micro-structure change in the market,” Nim said.

One-year onshore forward points are currently trading at around 320 points against 200 points in early December, showed Bloomberg data.

For foreign portfolio investors (FPIs), the impact is nuanced. While the new rules may constrain hedging flexibility, particularly for sectors with large currency exposures, they are unlikely to drive investors away on their own.

“I don’t think that this particular rule would be a reason enough for them (FPIs) to stay away from India if other things were to change,” Nim said, adding that broader risk-return considerations remain more critical.

So far in 2025-26, FPIs have initiated a record-breaking exodus from Indian equities, pulling out over ₹1.81 trillion, exceeding any previous full-year outflow. This massive capital flight, driven by geopolitical tensions in West Asia and surging oil prices, has caused the Indian rupee to weaken by 11% in the period, reaching its lowest level in over a decade.

In the near term, the RBI’s measures appear to have succeeded in cooling speculative activity. Since the NOP circular, the rupee had appreciated by nearly 2%, but it later erased these gains amid rising uncertainties from the West Asia war.

“Much of the recent movement in the rupee is now driven by fundamentals rather than trading positions. Practically all speculative positions were driven out… The hedge fund and the fast money are not running many positions on the currency,” Shailendra Jhingan, treasury head at ICICI Bank, said.

Instead, demand for dollars from importers, especially oil companies, has taken centre stage. “The move from 93 to 94–95 is more fundamentally driven by oil and less by speculation,” he said.

The regulator’s actions came as the country was already facing external sector pressures, including sluggish foreign direct investment (FDI) and uneven portfolio flows.

“The NOP circular doesn’t ease the pressure on the balance of payments, but you have to see the context in which RBI had spent close to $30 billion in March, and yet the rupee was getting close to 95,” Nim added.

The RBI’s forex reserves fell by nearly 6% in a month’s time to $688 billion as of 27 March. However, since the NOP circular, forex reserves have risen by over 2% to $703 billion as of 17 April.

Excessive control

At its core, the central bank’s intervention is about protecting macroeconomic stability, even if it means tighter control over market functioning.

But Marwaha warned that excessive controls could ultimately undermine confidence. “Constraints tend to reduce confidence rather than enhance it, and weaker confidence typically translates into currency depreciation,” he said.

He also flagged deeper structural issues, arguing that tactical interventions alone may not be sufficient. “The solution is not continued intervention…intervention is only a temporary measure. The issues at hand are structural and require structural responses.”

Meanwhile, depreciation pressures are likely to persist if global and domestic fundamentals remain unchanged. “Risk for the rupee is that we would be able to see 95–96 perhaps by the year’s end at the very least, if oil prices stay where they are… It’s more to do with the fundamental direction of the balance of payment,” Nim said.