India's Decade-Long Currency Clampdown Raises Fears of Backlash

India's Effort to Support Rupee Risks Scaring Away Global Investors

The Reserve Bank of India's (RBI) recent measures to stabilize the rupee may have inadvertently pushed away the global investors it has spent years wooing. The central bank's decision to force local banks to unwind bearish bets across onshore and offshore markets has resulted in a 2% gain in the rupee's value, but at a significant cost.

Banks Face Potential Losses

According to Jefferies Financial Group Inc., banks are staring at potential losses running into the hundreds of millions of dollars. Hedging costs have jumped, making it harder for investors to buy protection. Foreign investors, meanwhile, have slashed their bond holdings, with almost $1 billion cut from their holdings of index-eligible bonds.

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RBI's Measures Spark Concerns

The RBI's measures, which include capping banks' daily currency positions in local markets at $100 million and extending the curbs to offshore derivatives, have raised concerns about policy predictability and transparency. Sanjay Guglani, chief investment officer at Silverdale Capital Pte Ltd., described the RBI's steps as discretionary, adding that "this raises the bar for rupee assets among offshore investors."

History of Intervention

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The RBI's measures are not the first time the central bank has intervened in the foreign exchange market. In 2020, the RBI allowed local banks to trade the rupee in places like London and Singapore, and later let them offer these contracts to domestic clients. However, the latest measures are the most draconian yet, raising concerns about regulatory risk.

Impact on Foreign Investors

The RBI's measures have already had an impact on foreign investors, with some saying they may stay away from India even after the current uncertainties ease. One senior executive at a European bank said it would be difficult to return to the NDF market even after the RBI lifts restrictions because of the heightened perception of regulatory risk.

RBI's Commitment to Deepening Currency Markets

RBI Governor Sanjay Malhotra has said that the central bank remains committed to deepening currency markets and internationalizing the rupee. He added that the latest measures are only temporary and will not remain in place forever. However, the RBI's measures have raised concerns about policy predictability and transparency, and the impact on foreign investors remains to be seen.

Experts Weigh In

Some experts say the RBI's measures offer only limited relief for an economy facing a current-account deficit and capital outflows. High oil prices may worsen inflation and the deficit, accelerating the rupee's decline. The currency pressure isn't likely to dissipate soon given the war, said Rajeswari Sengupta, associate professor at Indira Gandhi Institute of Development Research in Mumbai.

Conclusion

The RBI's measures to stabilize the rupee have had a significant impact on the foreign exchange market, but the long-term effects remain to be seen. The central bank's commitment to deepening currency markets and internationalizing the rupee is laudable, but the measures have raised concerns about regulatory risk and policy predictability. As the situation unfolds, it will be interesting to see how foreign investors react and whether the RBI's measures are effective in stabilizing the rupee.