With the rupee depreciating rapidly in the wake of the Iran war and India’s oil and gas supplies choked by the Hormuz blockade, Prime Minister Narendra Modi went on air to urge citizens to curb expenditure on imports and foreign travel to conserve foreign exchange.
Around the same time, the Reserve Bank of India (RBI), which had been intervening in both the spot and forward markets to shore up reserves, announced measures to arrest the outflow of foreign currency.
This created an impression of India being in a 1991-like crisis. The country had almost run out of forex back then and had to deposit gold abroad as collateral to secure emergency loans. India is in no such situation today.
In early June, RBI governor Sanjay Malhotra reportedly said that India had enough reserves to cover 11 months of imports. So, what was the challenge? Was there some underlying problem?
India’s forex reserves had come down from an end-February peak of $728 billion to about $ 710 billion by mid-March and further to $691 billion by end-March amid the Gulf war and Hormuz blockade.
By early June, reserves fell further to $682 billion, but this still amounted to 11 months of import cover. After adjusting for net forward market dollar commitments amounting to $110 billion and exposure to short-term debt amounting to $235 billion, the reserve position worked out to a much lower net liquidity buffer of $337 billion.
However, that was still robust, amounting to 5-6 months of import cover, well over the prudential benchmark of three months.
Alternative metrics confirm this sound reserve position. A Guido-Greenspan (GG) ratio—the ratio of forex reserves to short-term external debt—of less than 1 indicates a country’s vulnerability to any ‘sudden stop’ in capital inflows, while a ratio of 1.5-2.0 is considered comfortable. India’s ratio works out to 2.9. Even netting out forward dollar commitments, it stands at 2.4, indicating a strong forex reserve position.
Another metric is the International Monetary Fund’s (IMF) ARA measure, a stress gauge of a country’s capacity to withstand multiple simultaneous shocks: an export-earning shock, a short-term debt rollover shock, portfolio capital outflows and broad money-capital flight risk.
The ARA is a weighted average measure of these risks. For countries such as India whose exchange rate is under a managed float, a reserves-to-ARA ratio of 100-150% is considered adequate. A ratio of over 150 is a strong buffer.
The IMF is reported to have estimated this metric at 130-170% for India based on gross forex reserves. Using reserves netted for forward dollar commitments, the ratio would work out to around 110-140%—still an adequate buffer.
Thus, even on very conservative assumptions, India’s reserve position is quite robust. Hence, it is hard to tell what drove RBIs recent interventions. More than the level, RBI is possibly concerned about the direction of change in forex reserves, which had declined further to under $672 billion by 12 June. It is also possible that the central bank is concerned about the changing composition of capital flows.
Though gross foreign direct investment (FDI) peaked at nearly $95 billion in 2025-26, most of it flowed out as repatriation ($53.6 billion) and outward bound FDI ($33.3 billion), leaving net FDI of under $7.7 billion. This is in sharp contrast to much higher retention in most other emerging markets in South America and Southeast Asia. These gaps call for close scrutiny of India’s policy environment.
Turning to foreign portfolio investment (FPI), there was a net outflow of $13.7 billion in March, mostly from equities. By 23 June, the net FPI outflow had come down to about $1.5 billion, with equity outflows of $5.7 billion mostly offset by net debt FPI inflows of $4.2 billion.
Evidently, removal of the long-term capital gains tax on government bonds for foreign institutional investors and withdrawal of the 20% withholding tax have proven effective in containing FPI outflows.
To further encourage debt FPI inflows, the government has expanded the list of securities under the Fully Accessible Route to include new issues with tenures of 15, 30 and 40 years.
Another RBI measure to attract foreign capital is to let foreign branches of Indian banks lend money to non-resident Indians (NRIs) for investment in its revised foreign currency non-resident (bank) or FCNR (B) deposit scheme, which offers banks protection against foreign currency and credit risk.
Indian banks can also issue standby letters of credit-guarantee to offshore banks lending against FCNR (B) deposits. This scheme is likely to boost such dollar deposits, as the nominal FCNR interest rate of 6-7% is higher than international floating rates and NRIs can expect high returns from arbitrage. If they leverage their deposits, annual returns could rise to a whopping 12-19%, that too without any exchange risk, according to a Times of India report.
The rupee has stabilized at 94-95 against the dollar, but RBI seems determined to break the cycle of expectations that has resulted in persistent, though now muted, outflows of capital. It will probably succeed in that endeavour. The question that will be debated is whether these measures were really necessary at such high cost, at a time when India’s forex reserves are quite robust.
The author is chairman, Centre for Development Studies.