RBI’s FX defence: After the swap scheme, back to the barricades

The Reserve Bank of India’s decision to unveil a fresh set of foreign-exchange restrictions soon after closing its $143 billion dollar swap scheme is more than a routine liquidity-management exercise. It signals that, despite a large reserve build-up, the central bank remains deeply concerned about rupee pressure, speculative positioning and renewed foreign-investor outflows.

The measures, ranging from a dedicated dollar window for oil refiners to a new reserve requirement on currency derivatives, echo the defensive playbooks of 1997-98, 2011-12 and 2013. They may calm markets in the near term. But they also raise an uncomfortable question: if India’s growth story is as strong as advertised, why does the currency still require barricades?

A four-pronged defence

Effective October 12, the RBI will meet the entire daily dollar requirement of Indian Oil Corporation, Bharat Petroleum and Hindustan Petroleum through designated banks. By removing the oil marketing companies’ commercial dollar demand from the interbank market, the central bank hopes to reduce immediate spot-market pressure (RBI).

The second set of measures targets the derivatives market. The RBI has banned the rebooking of cancelled rupee-linked FX contracts, cut the threshold for OTC derivatives that do not require an underlying exposure from $100 million to $5 million, and imposed stricter documentation to prevent duplicate or synthetic hedging (RBI). The message is clear: hedging is welcome; leveraged currency bets are not.

The most consequential step is the Foreign Exchange Risk Reserve, or FERR. Authorised dealers must now place with the RBI a cash reserve equal to 20 per cent of the rupee value of eligible FX derivative contracts above $2 million, maintained daily until the contract ends (RBI). On a $10 million hedge — about ₹100 crore at USD/INR of 100 — ₹20 crore must be set aside. That makes shorting or positioning in the rupee materially more expensive.

Finally, the RBI has tightened daily cash-reserve-ratio maintenance. Banks, which could earlier hold as little as 90 per cent of required CRR on a given day, must maintain 99 per cent from the fortnight beginning October 16, 2026 (RBI). The headline CRR is unchanged at 3 per cent, but the loss of daily flexibility absorbs liquidity at the margin and raises the cost of short-term funding.

A familiar playbook

None of this is unprecedented. During the Asian financial crisis, the RBI restricted rebooking of cancelled import forwards and curbed banks’ overnight open positions. In 2011-12, it again banned corporate rebooking, lowered dealers’ net open-position limits and capped forward cancellations. In 2013, after the Fed’s taper announcement triggered capital flight from “Fragile Five” economies, the RBI cut currency-derivative position limits, opened OMC swap windows and tightened documentation (RBI Bulletin).

The common thread is a shift from direct intervention to administrative friction and cost controls. Rather than selling reserves endlessly, the RBI is trying to make speculation expensive, separate genuine trade hedging from financial bets, and buy time for the currency.

Economic theory supports the use of such tools as tactical circuit breakers. The IMF’s Integrated Policy Framework recognises that capital-flow management and macro-prudential measures can reduce destabilising flows, especially when paired with monetary and FX intervention (IMF). But the evidence is equally clear that controls work best briefly. Over time, they invite circumvention, thin onshore liquidity and push activity into offshore non-deliverable forward markets.

Why the timing matters

The timing is striking because the RBI has just mobilised $143 billion through its swap scheme, including $133 billion of FCNR(B) deposits between June and August at roughly 11 per cent cost, alongside partial support for $5.3 billion of PSU external commercial borrowings. Banks had until September 11 to execute deposit-linked swaps; ECB and OFCB swaps close on December 31, 2026.

A larger war chest should, in principle, have strengthened the rupee. Instead, the central bank is tightening derivatives rules and liquidity conditions. That suggests the buffer is being consumed faster than expected.

Foreign currency assets (FCA) rose from $544 billion to a peak of $648 billion on September 4 — up $104 billion against nearly $140 billion mobilised — implying an underlying deficit of about $35 billion (see Chart 1). Since then, FCA has fallen to $604.7 billion. The $22 billion decline in reserves during 1QFY27 comprised an $8.1 billion balance-of-payments deficit and $14.4 billion of valuation losses.

Since March 2026, FCA has risen only $54 billion against $143 billion mobilised. That is a shortfall of about $90 billion in H1FY27, including valuation effects, or roughly $15 billion a month. If sustained, the swap mobilisation could be exhausted by the fourth quarter of FY27.

The cost of expensive stability

The larger risk is not merely reserve depletion. It is the quality and cost of the reserves being built. FCNR(B) deposits carry high interest costs, and the RBI has funded forward-cover costs as well. India may therefore end up paying for expensive foreign-currency liabilities for three to five years, even if the reserves they created are drawn down within a few quarters.

Meanwhile, growth capital remains weak. Net FII and FDI flows are at multi-decade lows relative to GDP, and FPIs have turned net sellers again, with outflows of about $10 billion in September-early October. A trade deficit that persists amid elevated crude prices, and weaker global risk appetite could accelerate the drain.

The currency arithmetic is unforgiving. With FCA at $604 billion and monthly imports estimated at $80 billion, import cover is 7.6 months. Total reserves of $734 billion provide 9.2 months of cover — close to the June 2026 lows and well below the long-term average of about 11 months (see Chart 2). If the pace of reserve erosion continues, USD/INR could experience renewed sharp weakening.

Rates, banks and equities

The FX defence is spilling into domestic monetary conditions. OMO sales of G-secs, VRRR auctions and stricter CRR maintenance are tightening liquidity just as the RBI has begun a rate-hike cycle. We expect inflation to peak at 6-7 per cent in 3QFY27, above the RBI’s 6 per cent projection, supported by raw-material cost inflation of about 40 per cent for companies in 1QFY27 and rising global rates. That points to a terminal repo rate of 6.5 per cent or higher.

For banks, deposit costs may rise faster than lending yields amid intense competition, compressing margins. For corporates, higher funding costs come on top of input-cost pressure. The manufacturing raw-material-to-sales ratio has risen by more than 800 basis points, threatening earnings.

Equities face a double squeeze: valuation compression from higher risk-free rates and currency depreciation, and earnings pressure from costs and interest outgo. With the Nifty 50 trading around 19 times earnings, near the upper end of our 18-19x fair-value range, the risk-reward turns less favourable if rate hikes persist and the 10-year G-sec yield moves above 7.5 per cent.

Stopgap, not solution

The swap scheme and the new controls reveal the limits of defending a currency with expensive, debt-funded reserves. They can suppress speculative activity and reduce near-term volatility, but they do not correct the underlying imbalance between India’s external funding needs and the quality of capital inflows.

Unless India revives private investment, improves manufacturing competitiveness, deepens export capacity and allows greater exchange-rate flexibility, foreign investors will continue to demand a higher risk premium. The RBI has returned to the barricades. The real test is whether policymakers use the time bought to repair the structural foundations — or merely postpone the next assault on the rupee.

The writer is CEO and Co-Head of Equities & Head of Research, Systematix Group. Views expressed are personal

Published on October 13, 2026