Not the usual monetary policy meeting: RBI steps in to defend the Rupee

For most of the inflation-targeting era, monetary policy announcements have revolved around one central question: what is happening to inflation? This time was different. While the Reserve Bank of India’s Monetary Policy Committee chose to leave the policy rate unchanged at 5.25 per cent and maintain a neutral policy stance, the real story was not inflation. The focus was the rupee itself.

To be sure, inflation risks are emerging. The RBI has flagged persistent geopolitical tensions, rising wholesale prices driven by higher crude oil and input costs, and the possibility of weather-related disruptions to agricultural output, leading to a potential rise in food inflation. Yet these risks have not materially reflected in consumer inflation so far. The inflation challenge remains a concern for subsequent MPC meetings. The depreciation of the rupee, however, is a problem of the present.

The currency has come under significant pressure in recent months amid rising crude oil prices, geopolitical uncertainty and foreign capital outflows. As global investors reassess risk in an increasingly volatile environment, emerging market currencies have borne the brunt of capital flight. India has been no exception. The pressure on the rupee is not merely a consequence of economic fundamentals; it is also shaped by expectations. Foreign exchange markets are inherently forward-looking. When investors expect a currency to weaken further, they often reposition their portfolios accordingly, creating a self-reinforcing cycle. Speculative pressures can amplify an initial decline, pushing the currency below levels justified by underlying fundamentals. In such circumstances, stabilising expectations becomes as important as stabilising the currency itself.

Traditionally, central banks respond to currency weakness through direct intervention in foreign exchange markets or by raising interest rates to make domestic assets more attractive. This time, the RBI has chosen a different route. Rather than sacrificing growth through higher interest rates or expending reserves aggressively in the forex market, the central bank has sought to strengthen the capital account and improve the attractiveness of India as an investment destination. This implies financing the current account deficit through capital inflows.

The measures announced alongside the policy decision reveal this strategy clearly.

First, the RBI expanded the Fully Accessible Route by including all new issuances of 15-year, 30-year and 40-year government securities, allowing foreign investors to invest in these bonds without being subject to investment caps.

Previously, foreign investors faced limits on how much they could invest in Indian government bonds. The FAR is a special category where those caps do not apply. By adding very long-duration bonds (15, 30 and 40 years) to this route, the RBI is specifically targeting long-term investors who want long-tenor assets and who were previously constrained.

Second, the RBI introduced concessional forex swap facilities to encourage External Commercial Borrowings (ECBs) by public sector enterprises, helping government-owned companies access cheaper overseas funding while increasing foreign currency inflows into the country. By making these borrowings cheaper through a swap facility, with the RBI bearing part of the currency hedging cost, it is incentivising Indian PSUs to borrow dollars abroad. Each such loan is a dollar inflow that supports the rupee.

Third, with the RBI bearing hedging costs and offering temporary regulatory relaxations, banks may be able to offer more attractive returns to NRIs on Foreign Currency Non-Resident (Bank) deposits. FCNR(B) deposits are fixed deposits held in foreign currency by NRIs in Indian banks. The bank and the NRI earn in foreign currency, which is then converted into rupees for use in India - a direct dollar inflow. The 2013 version of this scheme, launched during a major currency crisis, was considered a great success. The RBI is essentially trying to replicate that.

Fourth, the government announced through an ordinance that interest income and capital gains earned by Foreign Institutional Investors (FIIs) on government securities would be exempt from income tax, effective retrospectively from April 1, 2026. This removes two major tax costs: a 12.5 per cent long-term capital gains tax on government bonds held for more than 12 months, and a 20 per cent withholding tax on interest income from those bonds.

The objective is straightforward: to encourage stable capital inflows into India. Taken together, these are not conventional inflation-management tools. They are currency-stabilisation measures operating through the capital account.

The underlying logic is sound. India’s current challenge is not excessive domestic demand requiring monetary tightening.

It is an external-sector shock driven by higher oil prices, geopolitical uncertainty and global risk aversion. Raising interest rates in such a situation could impose unnecessary costs on growth while doing little to address the source of the problem. Attracting stable foreign capital, by contrast, directly addresses the pressure point.

The immediate market reaction suggests that investors understood the signal. The rupee registered its strongest single-day gain in two months following the announcements, as markets interpreted the measures as a credible effort to bolster foreign inflows and strengthen the balance of payments position.

Whether these measures prove sufficient will depend on the trajectory of global developments. If oil prices remain elevated, geopolitical tensions intensify, or capital outflows accelerate further, additional policy responses may become necessary. Yet the message from this monetary policy meeting is clear. This was not a meeting dominated by inflation concerns. It was a meeting focused on preserving currency stability in an increasingly uncertain global environment.

The writer is an Associate in Strategy & Research at Pahle India Foundation; Views presented are personal.