What's driving the rupee's long war

The RBI has thrown a wall of rules around the dollar, but the forces pushing the rupee towards 97 come from Washington, Frankfurt, Tokyo and the Strait of Hormuz, beyond the reach of Mint Street circularsThe two circulars landed in the small hours of Saturday, October 10, after New York had closed for the week, in the dry prose the Reserve Bank of India (RBI) reserves for its most aggressive moves. The communique framed them as measures to strengthen market discipline and ensure appropriate risk management. A third release, barely a paragraph long, announced that from October 12 the RBI would itself sell dollars to Indian Oil, Bharat Petroleum and Hindustan Petroleum, meeting their entire daily requirement so they no longer had to compete for greenbacks in the open market.By the time dealers in Mumbai’s Fort district reached their desks on Monday, the rupee had already told them what the market thought. It jumped roughly 1 per cent, pulling back from the brink of the record low of 96.97 to the dollar it had flirted with all week. Only five days earlier, on October 7, it had fallen to 96.85, the worst performer in Asia on the day governor Sanjay Malhotra raised interest rates for the first time in 44 months.The rally is real. What it proves is less clear. Since the start of 2026 the rupee has lost more than 7 per cent, foreign investors have pulled almost $30 billion out of Indian equities, and the RBI’s reserves have fallen from a record $785 billion in early September to $734 billion by October 2. The central bank has now intervened in the spot market, the forward market, the offshore market, the deposit market and the policy rate, and the currency has kept sliding. The question the weekend package poses is not whether the RBI can buy a day. It is whether it can buy a quarter.The October package is the fourth time this year the RBI has reached for the regulatory toolkit rather than the one in its monetary policy statement. On April 1 it barred banks from offering non-deliverable forwards (NDFs) and banned the rebooking of cancelled contracts; ten days later it capped banks’ net open rupee positions at $100 million. The rupee responded with its biggest rally in 12 years, then resumed falling, and on April 20 the RBI quietly withdrew the NDF ban while keeping the position cap. In mid-April it began supplying dollars to state refiners through credit lines at state-run lenders, a window the weekend’s release has now made official. From June it offered to bear the entire hedging cost on fresh Foreign Currency Non-Resident (Bank), or FCNR(B), deposits, a subsidy that pulled in more than $127 billion of overseas deposits by Reuters’ count before the window was shut early in August. The new measures go further on four fronts. The threshold for taking positions in rupee derivatives without proving an underlying exposure has been cut from $100 million to $5 million, both over the counter and on the exchanges. Cancelled contracts cannot be rebooked with any bank at all. Every hedger must sign an undertaking that the same exposure has not already been covered with another bank. And a new Foreign Exchange Risk Reserve requires banks to park cash with the RBI equal to 20 per cent of the notional value of rupee-linked current-account hedges above $2 million where a customer is buying foreign currency, locked up until the contract matures.The oil window is the most visible piece, and the one with a precedent. The RBI opened an identical facility for the same three companies in August 2013, in the last days of D. Subbarao’s governorship, when they were buying $8-8.5 billion a month during the taper tantrum. Today’s bill is larger and so is the price of crude. Estimates of the refiners’ daily dollar demand range from $200 million to as much as $550 million. Either way, the window does not shrink India’s oil bill. It moves the buyer from the interbank market to the RBI’s own balance sheet.Governor Malhotra’s public line has been steady. After the October 7 policy he said the bank would support orderly movement in the currency and insisted that by several measures, including the real effective exchange rate, the rupee was not overvalued and might even be undervalued. He has also closed off the easier route. Rate cuts, he said, are off the table in the near term; the only options ahead are a further hike or a pause.The WarpathTo understand why none of this has held, start in the Persian Gulf. When the United States and Israel went to war with Iran on February 28, Brent crude was trading near $57 a barrel, where it had begun the year. It was close to $90 by early March. It has settled above $100 three times since: for a full month in April and May, for a day in July, and again on September 9, after American forces destroyed five Iranian tankers and Houthi fighters struck Saudi oil installations. Lukman Otunuga of broker FXTM called the $100 mark “a major psychological milestone for markets”. The International Energy Agency now expects world oil supply to fall by 4.3 million barrels a day on average this year. India, which imports more than 85 per cent of its crude, is on the wrong side of every one of those barrels.The cushion that softened the 2022 oil shock is also gone. The February trade deal with Washington, which cut American tariffs on Indian goods from 50 per cent to 18 per cent, came with a price: India agreed to wind down its purchases of discounted Russian crude. New Delhi is paying Gulf prices for Gulf oil precisely when the Gulf is on fire.The second front is interest rates, and here the ground has shifted under every emerging market at once. The global rate-cutting cycle of 2024 and 2025 is over. In the four weeks before the RBI moved, six central banks on four continents raised rates. The US Federal Reserve lifted its benchmark to 3.75-4 per cent on September 16 in a unanimous vote, its first hike in three years, with the minutes showing most policymakers expect another by December; an October move has been priced out mainly because the meeting falls days before the midterm elections. The European Central Bank hiked in June and again on September 10, taking its main rate to 2.65 per cent as euro-area inflation hit 3.3 per cent. The Bank of Japan lifted its rate to 1.25 per cent on September 18, the highest since 1995, and still could not stop the yen sliding towards 160. South Africa, Norway and Australia followed within a fortnight, each citing oil. The Bank of England held at 3.75 per cent, but three of its nine members wanted a hike, with inflation heading for 4 per cent.Set against that, the RBI’s 25 basis-point move on October 7 looks modest. The repo rate stands at 5.50 per cent after 125 basis points of cuts in 2025. The gap between Indian and American policy rates is now about 150 basis points, a fraction of the five to six percentage points that made the rupee a comfortable carry trade a decade ago. That arithmetic, more than any speculator, is why foreign money is leaving.The bill for the new rules will be presented first to importers. Take a company that owes a supplier $10 million in three months and wants to lock in the rupee cost. At 96 to the dollar the forward is worth Rs 96 crore; the bank must now deposit Rs 19.2 crore of its own cash with the RBI for the life of that contract. Bankers told Reuters on October 12 that passing on the funding cost could add 80-150 basis points to hedging charges. On a three-month hedge of that size, that is Rs 19-36 lakh the importer did not pay last week.That is on top of what the rate hike already did. One-year hedging costs rose more than 60 basis points in the week after the October 7 decision, Reuters reported, and Nuvama’s head of fixed income, Ajay Marwaha, warned that the combination of an unstable rupee and dearer hedges would keep Indian equities relatively unattractive to overseas investors. The paradox is uncomfortable for Mint Street: a measure designed to choke speculative dollar demand also raises the price of the insurance foreign investors need before they bring dollars in.India is not alone, but it has chosen a different weapon. Bank Indonesia has raised rates to 5.75 per cent this year as the rupiah sank towards 18,000 to the dollar; the Bank of Korea has hiked twice since July, with the won near its weakest in 17 years. Jakarta and Seoul have leaned on interest rates. Mumbai has leaned on rules, and the rulebook it has borrowed is Beijing’s. The People’s Bank of China has run a foreign exchange risk reserve since October 2015: banks must park 20 per cent of the notional value of forward dollar sales to clients with the central bank, interest-free, for a year. The RBI’s version carries the same name, the same rate and the same purpose. China has treated it as a dial rather than a switch, imposing it after the 2015 devaluation, cutting it to zero in 2017, restoring it in the 2018 trade war, scrapping it in 2020 and bringing it back at 20 per cent in September 2022 as the yuan broke seven to the dollar. The rest of the pattern is familiar too: dollar sales through state banks rather than in the central bank’s own name, a squeeze on the offshore market, and documentation checks on who may buy dollars and why.The difference is what stands behind the rules. Beijing defends a currency with a daily fixing it sets itself, a current-account surplus and a capital account that was never fully open. India has none of those, and hedging advisers at Chatham Financial say the curbs have already thinned offshore liquidity, and widened the gap between onshore and offshore rupee pricing. India has adopted China’s rulebook for a currency it does not have China’s balance of payments to back. There is also a dollar overhang the circulars do not address. Reuters reported in September that banks had left at least half the interest cost on their $127 billion of new overseas deposits unhedged, because a hedge costs about 3 per cent a year, and dealers warned that a move to 96-97 could send them scrambling for dollars. The rupee has been inside that range for a week.Capital PerspectiveIn New Delhi, the finance ministry is watching the same numbers from the other side of the ledger. There is no public rift with Mint Street; Malhotra called on finance minister Nirmala Sitharaman in September and the vote of the RBI’s Monetary Policy Committee (MPC) was unanimous. But the ministry is squeezed on three sides, and each squeeze tightens with every paisa the rupee loses.The first is rates. In April, Sitharaman told the National Institute of Public Finance and Policy that India had the fiscal space to maintain its capital spending, and room for the RBI to cut rates and for supporting affected sectors. Six months later the RBI has delivered a hike, declared cuts off the table and pencilled in inflation of 6 per cent for the December quarter, which points to more. The government has a 7.8 per cent first-quarter growth print to protect and a borrowing programme priced off bond yields that rating agency ICRA already expects to stay elevated on fiscal risk.The second is fuel. On March 27 the Centre cut excise duty on petrol and diesel by Rs 10 a litre to keep pump prices steady; DBS put the full-year cost at about Rs 1.7 trillion, or 0.4-0.5 per cent of GDP, against a fiscal deficit target of 4.3 per cent. Fertiliser and petroleum subsidies were budgeted at Rs 1.83 trillion before crude went back above $100. A government source told Reuters that New Delhi is unlikely to pass higher crude prices on to consumers, partly because of opposition from states with assembly elections ahead. A weaker rupee raises the rupee cost of every barrel, so the ministry’s fiscal arithmetic and the RBI’s currency arithmetic are the same problem viewed from two buildings. Standard Chartered’s hope in July that cheaper oil would let the Centre reverse half the excise cut has evaporated.The third is quieter, and no one in government has said it aloud: the Budget leans on the RBI’s annual surplus transfer, and reserve sales at a record pace, together with the hedging losses the RBI has taken onto its own books on the FCNR(B) swaps, eat into that surplus. North Block has a direct fiscal stake not just in whether the rupee is defended, but in how. The new derivative curbs also sit awkwardly with the ministry’s own push to internationalise the rupee and build the Gujarat International Finance Tec-City (GIFT City) into an offshore hub, and with a trade deal whose $500 billion purchase commitment needs dollars flowing in, not out. The April rollback of the NDF ban, three weeks after it was imposed, is a visible sign that someone pushed back.Days of ResistanceInside the RBI, the oil window is understood as a replay of 2013, when the same facility for the same three refiners steadied the rupee within weeks. The comparison flatters. In 2013 the shock was a capital-flow scare set off by the Federal Reserve’s talk of tapering; it ended when the Fed blinked. The RBI had only to hold the line until Washington changed its mind.The closer parallel is 2022, when an energy shock after the invasion of Ukraine collided with the Fed raising rates at the fastest pace in four decades. The RBI’s answer then was not administrative. It raised the repo rate by 250 basis points between May 2022 and February 2023, and reserves fell by more than $100 billion from their 2021 peak, though much of that was valuation. A terms-of-trade shock cannot be waited out, and a global hiking cycle cannot be regulated away.The reserve numbers already carry the weight of that lesson. The $51 billion drop since early September came at the fastest weekly pace on record, and only part of it is valuation. India still holds one of Asia’s deepest cushions, enough for 11 months of imports by the finance minister’s reckoning. It is drawing on it at a pace it has never sustained before.The package buys time. What matters is what the time is used for, and most of the dates that will settle the rupee’s fate are on other people’s calendars. American inflation data on October 14 will shape the Fed’s October 28 meeting; the Bank of Japan meets the next day, with former board members predicting a hike a quarter until the rate reaches 2 per cent. The RBI’s committee does not sit again until December 2-4, with Nomura and SBI Research both expecting another 25 basis points.If Brent stays above $100 and the Fed hikes in December, as the United Overseas Bank (UOB) and others expect, then the circulars would have done their job for about six weeks and then met the limit of what circulars can do. At that point the choice the RBI has spent eight months deferring returns: higher rates that squeeze a 7.1 per cent growth forecast, or more reserves spent on a currency the governor insists is already undervalued.The RBI is not wrong that the rupee has been oversold, or that one-way bets fed on themselves. It may well be right that the oil window and the new reserve requirement take the panic out of the forward market. But the dollars India needs for its crude will still have to come from somewhere, the yield gap with America will still be the narrowest in a generation, and the war that started all this is not Mint Street’s to end. On Monday the market bought the rally. The weeks ahead will show whether it was buying the story.Subscribe to India Today Magazine- Ends