Biggest Currency Clampdown in Decade Risks Backfiring for India

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The experiences elsewhere offer a cautionary tale. China’s 2015-17 squeeze on offshore yuan liquidity stabilized the currency but triggered funding spikes and unnerved global investors. Malaysia’s 2016 clampdown on offshore ringgit trading curbed speculation while draining liquidity. In both cases, the moves carried reputational costs, underscoring the fine line India must navigate.

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Regulatory Risk

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Some market participants say the sudden policy shifts are prompting them to reassess the risks of operating in the market.

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Two senior foreign bankers said clients had questioned the RBI’s seemingly arbitrary move. They also asked: if speculative trades had become as large and destabilizing as policymakers suggest, why was it allowed to build up in the first place? The bankers asked not to be identified discussing private matters.

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Some foreign investors said they may stay away from India even after the current uncertainties ease, the bankers added.

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One senior executive at a European bank also 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. Participation may take years to recover, he said, asking not to be identified as those deliberations are private.

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As a result of the new measures, offshore 12-month forward points — a gauge of hedging costs overseas — jumped to their highest level since 2013, while the onshore costs hit the highest since 2022. Foreign investors have cut almost $1 billion from their holdings of index-eligible bonds. 

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Prashant Singh, a senior portfolio manager for emerging-market debt at Neuberger Berman Group LLC, said India’s onshore yields are becoming more attractive, but the external environment and recent regulatory steps have added to the uncertainty and increased currency hedging costs.

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“All of this makes taking active positions in India tricky over the near term, and we prefer to stay on the sidelines till we get more clarity,” Singh said.

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Jefferies estimates banks could face losses of up to 50 billion rupees ($539 million) from the forced unwinding. Bloomberg News previously reported that State Bank of India, the country’s largest lender, had about $5 billion in such positions and expects losses of around $32 million. 

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The RBI’s urgency reflects a deteriorating external backdrop, including higher US tariffs and a spike in energy prices after the Iran war — a toxic mix for an oil-importing economy with a persistent current-account deficit. Rising crude has inflated the import bill, while a global flight to safety has boosted the dollar. A two-week US-Iran ceasefire may offer some relief.

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RBI Governor Sanjay Malhotra said Wednesday the central bank remains committed to deepening currency markets and internationalizing the rupee, and that the latest measures don’t signal a shift in stance. In his first public remarks since the measures were introduced, he added that they’re only temporary and will not remain in place forever. 

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The Finance Ministry has reached out to external experts for ideas to stabilize the rupee, according to a person with knowledge of the matter, who asked not to be identified to discuss confidential matters. This reflects the government’s worry that foreign institutional investors may stay on the sidelines if depreciation risks increase, the person said. 

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An email to the Finance Ministry went unanswered, and the RBI didn’t immediately respond to a request for comment on concerns about regulatory risks among foreign investors and bankers.

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RBI Intervention

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Authorities have long been cautious about opening up to the NDF market, a key channel for speculative pressure during the 2013 taper tantrum. The RBI took a big step in 2020 by allowing local banks to trade the rupee in places like London and Singapore, and later let them offer these contracts to domestic clients. It has also, at times, informally urged banks to avoid building new offshore positions, but the latest measures are the most draconian yet.