The Rupee Cannot Be Defended by RBI Alone

The rupee is under renewed pressure. Rising crude oil prices triggered by the conflict in West Asia, disruptions in shipping routes through the Strait of Hormuz, persistent global uncertainty, and a strengthening dollar have combined to create nervousness across currency and debt markets. The Reserve Bank of India has reportedly intervened heavily in both spot and forward markets to prevent disorderly depreciation. Yet the rupee remains volatile and market sentiment fragile.

India imports nearly 85% of its crude oil requirements. Every sustained increase in oil prices widens the current account deficit, fuels imported inflation, raises fiscal pressures, and increases dollar demand in the system. But the present challenge goes beyond deteriorating external-sector arithmetic. The greater risk is that uncertainty may begin feeding speculative behaviour in financial markets.

Currencies rarely come under sustained pressure because of fundamentals alone. Markets can absorb weak data if they understand the sovereign’s policy response. What they cannot absorb is uncertainty about the state’s reaction function. When policymakers appear hesitant, fragmented, or reactive, markets begin creating their own narratives — and those narratives rapidly migrate into financial markets.

When the Forward Market Starts Driving the Currency

That process may already be underway.

Importers begin over-hedging against anticipated depreciation. Exporters delay conversion of export proceeds. Offshore non-deliverable forward markets are starting to influence domestic expectations. Forward premia then cease merely to reflect expectations; they begin generating them. Once that cycle gathers momentum, speculative pressure becomes self-reinforcing.

This is why the present situation cannot be viewed merely as a currency-management problem for the RBI.

A central bank can smooth volatility and prevent disorderly market conditions. But excessive visible defence of the currency also carries risks. If markets begin to believe that the RBI is defending an implicit exchange-rate threshold, speculation intensifies as traders test reserve adequacy and institutional tolerance. Even reserves exceeding $700 billion are not inexhaustible if markets perceive the intervention strategy to be tactical rather than strategic.

The Real Lesson from the 2013 Taper Tantrum

India has seen similar market dynamics before.

During the 2013 taper tantrum, following the US Federal Reserve’s indication that it would unwind quantitative easing, capital rapidly exited emerging markets. India, then burdened with a current account deficit of nearly 5% of GDP, elevated inflation, slowing growth, and weakening investor confidence, was among the most vulnerable economies. Between May and August 2013, the rupee depreciated by over 15% and briefly crossed 68 to the dollar — a deeply unsettling level at the time.

The stress was not confined to the spot market. Speculation in the forward markets intensified sharply. Investor sentiment turned decisively negative. The danger lay not merely in macroeconomic deterioration, but in the emergence of panic psychology.

The RBI initially responded through liquidity-tightening measures, including raising the marginal standing facility rate and restricting overnight liquidity access. These were necessary interventions. But it soon became evident that monetary tightening alone would not stabilise expectations. Markets needed to see a broader sovereign response.

What ultimately altered sentiment was coordinated action between the finance ministry and the RBI, combining orthodox and unconventional measures. The most significant among them was the FCNR(B) deposit mobilisation scheme announced by the RBI under gentle finance ministry persuasion. Indian banks were allowed to raise foreign-currency deposits from non-resident Indians while the RBI provided a concessional swap window to manage exchange-rate risk.

At the time, the proposal was criticised as risky and unconventional. Yet policymakers recognised a critical reality: Confidence crises cannot always be resolved through textbook orthodoxy. Sometimes the sovereign must create a sufficiently powerful signalling mechanism to reverse market psychology.

The scheme succeeded beyond expectations. Nearly $35 billion flowed into India within months. Speculative positions in the forward market unwound rapidly. Rupee pulled back to 59 to a dollar, before depreciating in a more orderly manner. More importantly, the narrative changed. Markets no longer believed India was running out of policy options.

The lesson from 2013 is not that India faces identical macroeconomic vulnerabilities today. It does not. India’s external position is considerably stronger. Banks are better capitalised, reserves are larger, and the current account deficit remains far below 2013 levels. But the behavioural dynamics of financial markets remain unchanged. Financial markets amplify uncertainty when policymakers appear reactive rather than anticipatory.

RBI Cannot Fight This Battle Alone

That is why the RBI cannot be left to defend the rupee alone.

The Ministry of Finance must now step forward with a visible and credible policy framework that combines short-term stabilisation measures with deeper structural reforms to restore investor confidence. Markets must see the government and the RBI acting in concert with a coherent external-sector strategy. Silence or ambiguity during periods of stress is often interpreted as uncertainty within the government itself. The finance minister and the DEA secretary must step out and speak to the markets.

Short-Term Stabilisation Measures

In the immediate term, policymakers may need calibrated measures to attract more stable foreign exchange inflows and reduce speculative pressure. These could include temporary diaspora-linked foreign-currency instruments, selective easing of external commercial borrowing norms for the infrastructure and export sectors, and structured financing arrangements for oil imports through bilateral currency settlement mechanisms.

The objective should not be to defend any particular exchange-rate level. It should be to prevent disorderly market behaviour and restore confidence in India’s external financing conditions.

Reforms as a Currency-Stabilisation Strategy

But crisis management alone will not suffice. Investors are not merely assessing whether India can defend the rupee today. They are assessing whether India remains an attractive long-term investment destination.

This is where the present response appears incomplete.

India requires a visible second-generation reform agenda that restores confidence in the country’s medium-term growth trajectory. In periods of global turbulence, capital discriminates sharply between emerging economies. Those perceived as drifting into policy uncertainty face disproportionately greater pressure on their currencies and financial markets.

The government must therefore use this moment to announce deeper reforms in areas that directly influence investor confidence: Tax certainty, faster commercial dispute resolution, electricity tariff reforms, revival of public-private partnerships, rationalising fuel taxes, deepening of corporate bond markets, and creation of more credible circular infrastructure-financing platforms to attract global pension and sovereign wealth funds.

Investors must be reassured that India remains committed to openness, competitiveness, and integration with global value chains.

 

Confidence Is India’s Strongest Reserve

The central lesson of the taper tantrum was that currency stabilisation ultimately depends not only on intervention, but on credibility. India stabilised the rupee in 2013 not by exhausting reserves, but by convincing markets that policymakers possessed coordination, strategic clarity, and the willingness to act decisively.

That lesson remains highly relevant today.

The challenge before policymakers is not merely to slow the rupee’s decline. It is to prevent temporary external stress from hardening into a broader loss of confidence in India’s policy direction and growth narrative.