By defending the rupee, India’s central bank is throwing the baby out with the bathwater

The Reserve Bank of India has spent the first months of 2026 defending the rupee, and the defense is costing more than the currency is worth protecting.

When the rupee touched an intraday low of 95.21 Indian rupees to the dollar on March 30 — a record, driven by capital flight, a Strait of Hormuz crisis that sent Brent crude to an intraday peak of $119 a barrel on March 19, and a broadly stronger dollar — the RBI sold dollars from its reserves, leaned on state-run refiners to ease spot dollar demand, and then reached for tools it had not used at this scale before.

On March 27, it capped banks' net open position in the onshore deliverable foreign exchange market at $100 million per business day, replacing a framework that had allowed exposures of up to 25% of total capital — positions that major lenders routinely ran between $1 billion and $5 billion. On April 1, it banned authorized dealer banks from offering rupee-linked non-deliverable forwards to any counterparty, severing the arbitrage channel between Singapore, London and Mumbai.

The intervention worked, in the narrow sense.

Market participants estimated the position cap forced the unwinding of between $25 billion and $50 billion in directional bets against the rupee. The currency snapped back from 95 rupees toward 93 rupees by mid-April. Reserves, which had fallen by $11.68 billion in the single week ending March 6 — the steepest weekly drop in more than a year — recovered above $700 billion.

On the face of it, the numbers looked good. But the economics signal a different story.

The RBI has a legitimate mandate to prevent disorderly markets. But there is a line between smoothing volatility and fighting fundamentals, and the central bank crossed it this time. What looks like prudent stewardship is, on closer inspection, a policy that trades long-term flexibility for short-term comfort, and charges the economy for the privilege.

Start with the direct costs.

The headline reserve number conceals a less reassuring picture beneath it.

The official forward book sat at a net short position of $68.4 billion in January 2026, rising to $77.7 billion by February — the highest since March 2025. By April, analysts at MUFG and Kotak estimated it had climbed to near or above $100 billion as the central bank rolled expiring contracts to avoid drawing down spot reserves. That doesn't read like a buffer. Rather a deferred liability the central bank will have to honor at whatever rate the rupee trades when those swaps mature.

Then there is the damage to monetary policy transmission.

To stop dollar sales from draining liquidity out of the banking system, the RBI conducted 2.5 trillion rupees (approximately $29 billion) of open market bond purchases between December 2025 and mid-March 2026, pushing the daily-average systemic surplus to around 2.5 trillion rupees ($29 billion) by early 2026. The result was a money market arbitrage that became impossible to ignore.

The overnight rate for the Triparty Repo Dealing System (TREPS) — a short-term instrument used by mutual funds and others to park surplus cash in government-backed securities — fell as much as 75 basis points below the Standing Deposit Facility rate. Banks responded the way banks always respond to risk-free spreads: they parked nearly 5 lakh crore rupees ($58 billion) back at the central bank rather than lending it out. The repo rate held at 5.25%, but effective borrowing costs for businesses rose. Government security yields drifted up. This is what a clogged transmission channel looks like, and it arrived at exactly the moment the RBI's own Monetary Policy Committee cut its FY27 GDP forecast by 50 basis points to 6.9% — from 7.4% in February — against an FY26 actual of 7.6%.

The administrative measures introduced their own distortions.

Jefferies estimated that the ban on non-deliverable forwards — cash-settled contracts that fix the difference between an agreed rate and the spot rate at maturity, settling in dollars rather than the restricted currency — would generate mark-to-market losses of 3,000 to 4,000 crore rupees ($350 million to 465 million) per rupee of INR/USD movement across the banking system, with foreign and private lenders bearing the bulk of the pain. Foreign banks argued — credibly — that they could no longer manage rupee exposure for global multinational clients out of Mumbai.

By April 20, the RBI had already begun rolling back parts of the ban, permitting related-party rollovers and back-to-back hedging after it became clear that genuine importers and exporters were being squeezed alongside speculators. The $100 million position cap stayed. The pattern is familiar from previous intervention cycles: throw up the wall, watch the wall break things, take pieces of it down, leave the rest.

The deepest problem is what the intervention forgoes.

It would help if the RBI learnt to reframe the problem at hand, rather than adopt a rigid approach steeped in tradition. A depreciating currency signals price — it does not represent a policy failure.

India's Real Effective Exchange Rate (REER) told this story before the Middle East shock did.

India's 40-currency REER reached 108.14 in November 2024 — roughly 8% above its 2015-16 base, a record high. It only crossed back below 100 recently. And what does the export data show during this stretch of supposed competitiveness gains?

The Global Trade Research Initiative reported that textiles and garment exports fell 2.2% in 2025-26 to $35.8 billion, a shortfall the sector could ill afford. Cotton textiles fell 3.9%. Ready-mades fell 1.4%. These sectors grew in rupee terms and shrank in dollar terms, which is the textbook signature of an economy losing market share to competitors whose currencies are doing what currencies are supposed to do.

That dynamic is not surprising given the structure of Indian manufacturing.

Import intensity is high across most sectors, meaning gains from a weaker rupee on the export-revenue side are partially offset by rising input costs before they even reach the bottom line.

The 93 rupees versus 95 rupees dispute needs careful framing. A two-rupee move is roughly 2% — too small, on its own, to restore the competitiveness the REER data documents. The real indictment is cumulative. India's trade-weighted exchange rate stayed lodged above 100 for most of the period since 2022, and above 108 at its peak, in large part because the RBI kept managing each depreciation cycle rather than allowing orderly adjustment.

The March 2026 intervention is not an isolated line in the sand.

It is the latest episode in a sustained pattern — one that collectively kept the REER elevated long enough for Indian exporters to cede market share in exactly the sectors the data now confirms. The currency has only recently corrected back below the 100 baseline. Defending it here is not a neutral act: it is an implicit claim that the adjustment is now complete, when the export evidence says it is not.

What the RBI can do — and keeps doing — is delay the price signal that would push manufacturers and policymakers alike to address the underlying competitive weaknesses.

India's vulnerabilities are not rupee problems. They are structural problems.

The country imports nearly 90% of its crude oil. At $85–$95 oil per barrel, Yes Securities projected the current account deficit could triple to around $70 billion in FY27 — from $23 billion in FY25.

The services sector and a $135.4 billion annual remittance flow do the heavy lifting on the external account, with roughly 38% of those remittances still originating from the Middle East — the same region that spent March 2026 on the brink of a wider war. In March alone, foreign portfolio investors pulled a record 1.17 lakh crore rupees ($13.6 billion) from Indian equities, eclipsing the prior monthly record set in October 2024. 

Defending a particular rate level addresses none of this. 

It does give politicians and industry lobbies a number to point to, which may explain some of the pressure on the central bank to hold the line.

The RBI is not naive about any of this, and it should not let the market think it is.

The intervention sits within a long tradition of emerging-market central bank behavior: act aggressively, absorb the political heat, hope global conditions turn before reserves run thin. With $700 billion on hand, an external-debt-to-GDP ratio of 19.2%, and reserves covering 94% of the country's $746 billion in external debt, India has relatively more dry powder than most emerging markets, and far more than the East Asian economies that broke in 1997. The architecture is genuinely robust.

But the logic of the intervention trap travels beyond fixed-rate regimes.

Each cycle trains markets to expect the next move, encouraging positioning that forces the bank's hand sooner. Administrative caps layer up and become harder to unwind without signaling weakness — as the partial NDF rollback on April 20 illustrates.

The forward book grows. And the bet underneath all of it — that the Middle East shock is transient — has to keep paying off month after month, or the cost of holding the line becomes prohibitive. Goldman Sachs has forecast a further 50 basis points of rate increases by the RBI in 2026, while simultaneously cutting its India GDP forecast to 5.9% and raising its CPI estimate to 4.6%. That is not a benign backdrop in which to be running a $100 billion forward book.

If Brent stays above $100 for twelve to eighteen months, the RBI is not preventing an adjustment. It is choosing the point on the timeline at which that adjustment happens, and how concentrated the pain will be when it does.

A credible monetary policy anchored to the 4% inflation target, paired with a more flexible exchange rate, would serve India better than the current program. Use reserves for genuine sudden-stop scenarios. Address the questions that intervention cannot answer: why a country with India's labor cost advantage cannot grow textile and other manufacturing exports in dollar terms, why nearly 90% of its crude is imported, and why services and remittances still carry the external account.

The baby is India's growth potential and the export competitiveness that must underpin its 2047 ambitions. The bathwater is the anxiety about what the rate board says on any given Tuesday.

The RBI keeps throwing them out together. It should stop.