RBI should deepen financial markets rather than rely on restrictions

The Reserve Bank of India (RBI) this week constituted a technical consultative committee for financial markets. It is expected to facilitate structured engagement with market participants and stakeholders on policy and operational issues relating to money markets, government securities, foreign-exchange markets, derivatives markets, and infrastructure. The committee, with most members drawn from outside the central bank, should help enable more informed intervention. Any such committee of experts that provides a forum for discussion involving market participants with the objective of improving the functioning of financial markets must be welcomed, particularly against the given backdrop. 

The evolving global economic and financial conditions have resulted in significant volatility in the Indian financial market. While equity and bond markets have witnessed volatility over the past several months, the RBI’s focus has largely been on the currency markets. Although the rupee has gained over the past few trading sessions, it has been under considerable pressure, at least since the beginning of the Iran war. India faced the prospect of an increased current-account deficit along with persistent outflows on the capital account. The RBI also announced swap schemes to attract foreign flows and build buffers. It has used foreign-exchange reserves to stem the decline in the rupee. India’s foreign-exchange reserves have declined by about $66 billion from the record highs of $785.7 billion in the week ended September 4. It has also put various restrictions in the market for currency derivatives with a view to containing speculation. 

It is in this context that the committee will have consultation with stakeholders. It is hoped that its deliberations and consequent RBI intervention will be made public for wider discussion. Notably, one of the terms of reference for the committee is: “Emerging policy and operational issues affecting financial markets, including implementation of RBI measures and identification of unintended market frictions.” This is a crucial aspect, and it would be interesting to know the views of the committee. One of the issues has been the level of central-bank intervention. As one of the experts pointed out on these pages recently, in 2025-26, the RBI bought government bonds worth about 2.5 per cent of gross domestic product, which was over 80 per cent of net central-government borrowing. This partly compressed government bond yields and reduced the yield difference with other markets, and may have affected capital flows. The RBI intervention was to improve liquidity, which got drained owing to foreign-exchange outflows and intervention in that market. More recently, the RBI was busy draining liquidity out of the market. Liquidity increased substantially with large inflows under the Foreign Currency Non-Resident (Bank) deposits. The data shows that the RBI also had a net short dollar position worth about $240 billion in the forward market at the end of September. Clearly, it is trying to manage various things in the market.  

It must be accepted that spillovers from global markets often complicate things in emerging-market economies. However, it must also be recognised that as India gets more integrated with the global economy, partly owing to new free-trade agreements, it will become increasingly difficult for the RBI to influence market outcomes without creating friction. For instance, last financial year, India exported goods and services worth over $850 billion, while imports stood above $950 billion. Thus, nearly about $2 trillion crossed the Indian borders in a year on just the trade account. Therefore, the need is to develop markets, not restrict them, and allow economic agents to take informed business decisions. The expert committee should be expected to draw up a fresh road map.