Malhotra's “Whatever It Takes” Moment

The focus ahead of every Monetary Policy Committee meeting inevitably turns to whether the Reserve Bank of India will raise rates, hold them steady or alter its policy guidance. Yet the questions confronting policymakers today extend beyond the level of the repo rate. A third consecutive year of balance of payments pressure, elevated crude oil prices, persistent capital outflows and a widening gap between credit growth and deposit mobilisation are beginning to test the availability of funding required to sustain India's growth momentum.

India's macroeconomic position remains considerably stronger than it was during earlier episodes of external stress. Foreign exchange reserves are substantially larger, the policy framework is more credible, and the economy is less vulnerable to sudden disruptions in external financing. Nevertheless, comparisons with 1991 or 2013 miss the nature of the current challenge. The issue today is not one of reserve adequacy or external solvency, but whether India can continue attracting the volume and quality of capital required to support growth at a time when global investors have become increasingly selective.

India may well be one of the world's fastest-growing major economies while simultaneously witnessing one of the fastest episodes of capital outflows in recent years.

Investors argue that equity outflows over the past two years have effectively offset much of the equity capital attracted over the preceding decade. Whether one agrees with the exact arithmetic or not, the shift in investor sentiment is difficult to ignore.

Viewed through that lens, the RBI's recent activity in the dollar-rupee forward market becomes particularly interesting.

Swap Signals
Over the past two weeks, the three-year MIFOR has fallen by nearly 50 basis points to around 6.85%, while one-year forward-implied yields have declined by roughly 40 basis points to around 3%. Reuters reported this week that one-year forward premiums had fallen to around 2.9%, reflecting aggressive activity in the swap market. While these movements may appear technical, they materially alter the economics of overseas borrowing for Indian institutions.

Market participants estimate that the RBI may have undertaken buy-sell swap transactions of roughly $10 billion in recent weeks. Such operations allow the central bank to influence forward-market pricing without creating the domestic liquidity impact that would normally accompany outright dollar sales. They also enable the RBI to roll over a portion of its shorter-dated forward exposures into longer maturities while simultaneously compressing hedging costs across the curve.

Market estimates suggest that the RBI's forward book may now consist of roughly $39 billion of maturities within one year and about $62 billion of maturities beyond one year. While these numbers cannot be independently verified from public disclosures, they point to an increasingly deliberate effort to extend the maturity profile of the forward book while reducing pressure on the shorter end of the curve.

The significance of this strategy becomes clearer when viewed alongside conditions in the domestic funding market.

Credit growth continues to outpace deposit growth, forcing banks to compete more aggressively for funding. Some market estimates suggest that every ₹100 of incremental deposits is currently supporting nearly ₹135 of incremental credit creation, a mismatch that inevitably pushes wholesale funding costs higher.

The resulting pressure has been reflected in elevated wholesale funding costs. Three-month certificates of deposit recently traded near 7.5% before easing modestly to around 7.25%, while one-year certificates of deposit continue to trade around 8%. Elevated funding costs have also widened corporate bond spreads, particularly in the two-to-five-year segment, making bank credit relatively more attractive and reinforcing the very imbalance policymakers are attempting to address.

Funding Mismatch
What begins as a banking-sector funding mismatch eventually feeds through to borrowing costs across the economy. Higher funding costs influence investment decisions, borrowing behaviour and monetary transmission, particularly in a financial system where banks remain the dominant source of credit.

The pressure on deposits is becoming increasingly visible. According to market estimates, deposits have contracted by around ₹5.4 trillion so far in 2026-27, compared with an increase of roughly ₹3.07 trillion during the corresponding period a year earlier. Even after adjusting for liquidity effects associated with maturing repo operations, the contrast is striking and has heightened concerns about the availability of domestic funding.

Even after adjusting for roughly ₹0.41 trillion of liquidity effects associated with repo maturities at the end of April, the deposit numbers remain unusually weak by historical standards.

Against this backdrop, lower hedging costs assume greater significance because they improve the economics of raising funds overseas.

If three-year MIFOR rates move closer to 6.5%, and strong Indian borrowers are able to access dollar funding at spreads of roughly 85-90 basis points, consistent with where several high-quality Indian issuers trade in secondary markets, the all-in cost of borrowing could approach 7% after accounting for hedging costs. For large public-sector banks and financial institutions, that compares favourably with domestic three-year fixed deposit rates of around 6.75%.

The attraction is not merely the marginal difference in cost. It is the ability to mobilise large pools of funding at a time when domestic deposits are becoming increasingly scarce. Large public-sector banks and development finance institutions could potentially access sizeable overseas funding at an all-in cost only marginally above domestic deposit rates while simultaneously diversifying their funding sources.

That the supply of high-quality Indian dollar credits remains relatively limited and that issuance of $50 billion-$60 billion could potentially be absorbed by global investors over a relatively short period. This remains an author's estimate rather than a forecast, but it reflects the depth of demand that many investors believe exists for strong Indian credits.

Taper Redux?
This is where the comparison with 2013 becomes relevant, as during the taper tantrum episode, the RBI explicitly provided concessional swap facilities to attract foreign currency deposits from non-resident Indians.

Considerable debate followed because the RBI effectively provided a concession of roughly 350 basis points on forward-cover costs to participating banks. The scale of that concession became one of the most discussed aspects of the scheme.

The current approach appears more subtle. Rather than announcing an explicit subsidy, policymakers may be attempting to achieve a similar outcome through market pricing, thereby lowering hedging costs and reducing the effective cost of overseas borrowing.

The government also has a role to play.

Reports that policymakers are considering the removal of long-term capital gains tax and withholding tax on foreign investments in Indian government securities would represent an important step in improving India's attractiveness to global investors. The revenue implications are modest relative to the potential benefits.

Foreign portfolio investors currently hold roughly ₹3 trillion of Indian government bonds.

Withholding tax on these investments is currently around 20%, yet the resulting revenue is widely estimated by market participants to be only around ₹10 billion-₹20 billion annually, making it one of the lowest-hanging reforms available to policymakers seeking to attract stable debt inflows.

More importantly, such measures would reduce friction for long-term investors and strengthen India's integration with global fixed-income markets. The removal of capital gains tax could also improve the conditions necessary for broader participation through international settlement systems such as Euroclear, further expanding the potential investor base for Indian government securities.

Necessary, Not Sufficient Conditions
None of these measures is likely to prove sufficient in isolation. The effectiveness of the broader strategy will depend on whether liquidity management, external-sector policy, banking-sector funding and capital-market reforms reinforce one another rather than operate as separate initiatives. The RBI can influence funding conditions and hedging costs, while the government can reduce barriers to foreign capital and improve market access. Together, such measures would address both the scarcity of dollars and the tightening availability of deposits that increasingly characterise current financial conditions.

Whether the MPC ultimately raises rates, pauses or adopts a more nuanced approach may prove less consequential than the accompanying measures aimed at improving access to both dollar funding and domestic liquidity. Investors already understand the cyclical challenges posed by higher oil prices and a less supportive global capital environment. What markets are likely to watch more closely is whether policymakers demonstrate a coherent strategy for ensuring that India continues to attract capital and maintain adequate funding for growth.

A coordinated response that simultaneously addresses external financing, domestic liquidity and market access may ultimately prove more consequential than any single interest-rate decision, particularly if policymakers conclude that the time has come for their own version of a "whatever it takes" response.