Chin, chin, here’s to the rupee
RBI has historically possessed a remarkable 'Break glass in case of emergency' toolkit. In 1998, faced with post-Pokhran sanctions, it launched Resurgent India Bonds (RIBs) and raised $4.2 bn. In 2000, India Millennium Deposits (IMDs) brought in $5.5 bn. And in 2013, during the 'taper tantrum', FCNR(B) swap window attracted over $30 bn, single-handedly arresting a 14% rupee freefall.
Today, with rupee breaching 96 to dollar, oil above $100 and CAD widening, whispers of a similar 'bazooka' are growing louder in policy circles. The temptation is understandable. But the global interest rate environment of 2026 has blunted this toolkit. Raising rates is no longer a policy option but a policy imperative.
Success of India's previous forex mobilisation schemes rested on one crucial foundation: a massive yield differential between India and the developed world. The 'carry' for an NRI borrowing in dollars and depositing in India was enormous.
In 2013, when RBI offered banks a subsidised 3.5% swap rate on FCNR(B) deposits, US rates were effectively zero, enabling Indian banks to raise short-tenure dollar deposits at 2-3%, and longer-tenor deposits at 3-4% rates. Banks were further incentivised through exemptions from CRR and SLR requirements, making the economics irresistible, and this 'leveraged carry trade' led to a 12% boost to forex reserves and rupee appreciating by 6% over the following 6 mths.
Today, that arbitrage has evaporated. The US federal funds rate sits at 3.5-3.75%. The 10-yr US treasury yields are over 4.5% and 30-yr is well over 5%. Long bond yields in markets across the world from Japan to Europe are at levels rarely seen in past two decades. In this environment for India to offer a 'special bond' attractive enough to mobilise $25-30 bn, it would need to be priced at US treasury plus 150-200 bps - implying a dollar coupon of 6% or higher.
Factoring in hedging costs, the all-in cost well exceeds the domestic borrowing rates for banks, even if accompanied by forbearances on reserves (SLR/CRR). Potential of RBI taking on all/part of the currency exposure also has to be seen in context of its existing forward swap short book of over $100 bn.
The marginal impact has diminished. In 1998, $4.2 bn represented an 18% boost to reserves. Today, with reserves near $700 bn, even a $30 bn raise would add barely 4%. The signalling effect that calmed markets in 2013 would be lot more modest in 2026.
The issue isn't one of financial plumbing but of price. India's domestic interest rates are currently appearing too low relative to the global environment to attract and retain capital, in particular debt capital.
While several reasons are accorded for foreign portfolio outflows in equities (high valuations, taxation, lack of AI, etc), the trend in debt flows is not too different. FPI flows into Indian debt, which surged after JP Morgan index inclusion in 2024, have turned tepid as real yield pickup over US treasuries compressed and witnessed net outflows in 2026.
Stripping out the 'index effect', the organic trend in FPI debt flows has been negative or flat since FY21, a direct consequence of compression of 'India Premium' in a 'higher for longer' world.
External commercial borrowings (ECBs) - historically a reliable conduit for corporate dollar inflows - have been declining steadily. Indian corporates borrowings through ECBs dropped 30% y-o-y to $43 bn in FY26, from $61 bn in FY25. RBI's relaxation of ECB guidelines earlier this year has also not shown any impact, and ECB borrowings in March 2026 were down 50% y-o-y.
Any moves to address tax issues, like withholding tax, will certainly be helpful. But in the current global rate environment, it's unlikely to materially turn the tide of capital flows. If India's own blue-chip corporates find global dollar markets unattractive, why would global investors find rupee-denominated assets attractive at current yields? The 'yield shield' that once protected our capital account has been thinned out.
With a widening CAD, accelerating currency depreciation and rising inflation (even though supply-led), a hike in rates is now a policy imperative rather than policy option. Defending a currency solely through forex intervention is a Sisyphean task - you roll the stone up the hill by selling dollars, only for the market to push it back down.
A rate hike is a much more potent defence. It increases the rupee's 'carry', making it expensive for speculators to short the currency, bolster inflation-fighting credibility of RBI to global investors; and dampen non-essential import demand, easing pressure on CAD.
True, rate hikes will moderate the broader economic momentum and raise burden on MSMEs and home borrowers. But so will continued pressure on the currency. The alternative - burning through reserves while hoping oil prices fall and the Fed pivots - is a strategy of hope.
RBI's extraordinary bond schemes worked in a world of zero global rates and leveraged carry trades. That world is gone. In 2026, the only credible defence of rupee is the oldest tool in the central banker's kit: the interest rate. It's time to use it.
The writer is former CIO, Axis AMC
Today, with rupee breaching 96 to dollar, oil above $100 and CAD widening, whispers of a similar 'bazooka' are growing louder in policy circles. The temptation is understandable. But the global interest rate environment of 2026 has blunted this toolkit. Raising rates is no longer a policy option but a policy imperative.
Success of India's previous forex mobilisation schemes rested on one crucial foundation: a massive yield differential between India and the developed world. The 'carry' for an NRI borrowing in dollars and depositing in India was enormous.
In 2013, when RBI offered banks a subsidised 3.5% swap rate on FCNR(B) deposits, US rates were effectively zero, enabling Indian banks to raise short-tenure dollar deposits at 2-3%, and longer-tenor deposits at 3-4% rates. Banks were further incentivised through exemptions from CRR and SLR requirements, making the economics irresistible, and this 'leveraged carry trade' led to a 12% boost to forex reserves and rupee appreciating by 6% over the following 6 mths.
Today, that arbitrage has evaporated. The US federal funds rate sits at 3.5-3.75%. The 10-yr US treasury yields are over 4.5% and 30-yr is well over 5%. Long bond yields in markets across the world from Japan to Europe are at levels rarely seen in past two decades. In this environment for India to offer a 'special bond' attractive enough to mobilise $25-30 bn, it would need to be priced at US treasury plus 150-200 bps - implying a dollar coupon of 6% or higher.
Factoring in hedging costs, the all-in cost well exceeds the domestic borrowing rates for banks, even if accompanied by forbearances on reserves (SLR/CRR). Potential of RBI taking on all/part of the currency exposure also has to be seen in context of its existing forward swap short book of over $100 bn.
The marginal impact has diminished. In 1998, $4.2 bn represented an 18% boost to reserves. Today, with reserves near $700 bn, even a $30 bn raise would add barely 4%. The signalling effect that calmed markets in 2013 would be lot more modest in 2026.
The issue isn't one of financial plumbing but of price. India's domestic interest rates are currently appearing too low relative to the global environment to attract and retain capital, in particular debt capital.
While several reasons are accorded for foreign portfolio outflows in equities (high valuations, taxation, lack of AI, etc), the trend in debt flows is not too different. FPI flows into Indian debt, which surged after JP Morgan index inclusion in 2024, have turned tepid as real yield pickup over US treasuries compressed and witnessed net outflows in 2026.
Stripping out the 'index effect', the organic trend in FPI debt flows has been negative or flat since FY21, a direct consequence of compression of 'India Premium' in a 'higher for longer' world.
External commercial borrowings (ECBs) - historically a reliable conduit for corporate dollar inflows - have been declining steadily. Indian corporates borrowings through ECBs dropped 30% y-o-y to $43 bn in FY26, from $61 bn in FY25. RBI's relaxation of ECB guidelines earlier this year has also not shown any impact, and ECB borrowings in March 2026 were down 50% y-o-y.
Any moves to address tax issues, like withholding tax, will certainly be helpful. But in the current global rate environment, it's unlikely to materially turn the tide of capital flows. If India's own blue-chip corporates find global dollar markets unattractive, why would global investors find rupee-denominated assets attractive at current yields? The 'yield shield' that once protected our capital account has been thinned out.
With a widening CAD, accelerating currency depreciation and rising inflation (even though supply-led), a hike in rates is now a policy imperative rather than policy option. Defending a currency solely through forex intervention is a Sisyphean task - you roll the stone up the hill by selling dollars, only for the market to push it back down.
A rate hike is a much more potent defence. It increases the rupee's 'carry', making it expensive for speculators to short the currency, bolster inflation-fighting credibility of RBI to global investors; and dampen non-essential import demand, easing pressure on CAD.
True, rate hikes will moderate the broader economic momentum and raise burden on MSMEs and home borrowers. But so will continued pressure on the currency. The alternative - burning through reserves while hoping oil prices fall and the Fed pivots - is a strategy of hope.
RBI's extraordinary bond schemes worked in a world of zero global rates and leveraged carry trades. That world is gone. In 2026, the only credible defence of rupee is the oldest tool in the central banker's kit: the interest rate. It's time to use it.
The writer is former CIO, Axis AMC
Ashish Gupta
He is former CIO, Axis AMC