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.
The author is associate professor of economics, IGIDR, Mumbai. The views are personal
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