India mounts costly rupee defence as RBI intervention drains reserves

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India mounts rupee defence

Highlights

The Reserve Bank of India has spent about $90bn since June from diaspora resources and reserves to support the rupee, which is down 5 per cent against the dollar this year.
India’s central bank reserves have dropped by $60bn from a September peak of $785bn, with net forward dollar liabilities rising to $200bn in August from $137bn in July.
The RBI raised policy rates by 0.25 percentage points to 5.5 per cent after September inflation reached 5.5 per cent, nearing its 6 per cent tolerance limit.

RBI steps up market support measures

As first reported by Financial Times, the Reserve Bank of India has used about $90bn since June from more than $140bn raised from the Indian diaspora to support the rupee, according to two foreign-exchange bankers familiar with the operations. The intervention includes dollar sales in the spot market and currency swaps aimed at absorbing surplus liquidity.

The rupee is among Asia’s weakest-performing currencies this year, down 5 per cent against the dollar. Higher crude prices linked to the war in Iran are raising India’s energy import bill, while record foreign selling of Indian equities is adding to pressure on the currency.

As the rupee nears fresh lows this month, the RBI takes several unusual steps to reduce volatility. These include opening a special window to absorb state oil companies’ dollar purchases away from the spot market, lowering the threshold for rupee-linked derivative transactions without proof of underlying exposure, and requiring dealers to maintain a 20 per cent cash reserve on forward contracts with the central bank.

Those measures add to earlier steps such as curbing short positions against the rupee and seeking deposits from Indians living abroad. The rupee has strengthened 0.7 per cent over the past week to about Rs94.5 per dollar on Thursday, its highest level in six weeks, with foreign inflows tied to the public offering of Jio Platforms also providing support.

Reserve costs and policy limits draw focus

Bankers and economists say the RBI cannot continue drawing on foreign exchange buffers at the current rate indefinitely. The central bank’s reserves have fallen by about $60bn from an early September peak of $785bn, while net forward dollar liabilities rise to $200bn in August from about $137bn in July, according to official data.

Dhiraj Nim, a Mumbai-based economist and foreign exchange strategist at ANZ Group, says the current pace is not sustainable because reserves are finite and forward obligations are large. He adds that the RBI is also reluctant to raise interest rates aggressively because of the broader effect on growth, with India’s annual GDP growth slowing to 7.8 per cent in the quarter to the end of June from 8.6 per cent in the previous quarter.

The central bank this month raises interest rates for the first time since 2023, lifting the policy rate by a quarter point to 5.5 per cent after inflation accelerates to 5.5 per cent in September, close to the RBI’s 6 per cent tolerance limit. Nim says more aggressive hikes cannot be ruled out if currency moves become disorderly, and adds that the RBI appears to have drawn a line at Rs97 per dollar.

RBI governor Sanjay Malhotra says in a local media interview this month that the central bank remains committed to a stable rupee but does not target a specific exchange rate or band. He also rejects suggestions that recent measures amount to capital controls, saying they are intended to ensure the market serves genuine hedging needs rather than speculative bets.

Krishna Srinivasan, the IMF’s Asia-Pacific director, says in Mumbai on Wednesday that India should allow the exchange rate to move as the first line of defence against the ongoing oil shock. Miguel Chanco, chief emerging Asia economist at Pantheon Macroeconomics, says Malhotra has been more explicit about allowing the market to broadly determine the exchange rate, with the RBI’s role limited to curbing excess volatility, an approach now being tested by the fallout from the war in the Middle East.

In our earlier article on the RBI’s rupee-defence operations, we covered estimates that the central bank had deployed roughly $75–$80 billion from its special FX measures launched in June via spot dollar sales and swap transactions. We also noted the accompanying drop in reserves, the build-up of forward liabilities, and warnings that the RBI’s room to keep defending the currency may be tested if the rupee approaches around Rs97 per dollar again.

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