The RBI’s recent slew of FX measures and tighter market access has steadied the spot rupee market, but the stability is optical and policy-engineered, not organic flows-driven and has come at the cost of a sharp dislocation in the forward market. Restrictions can suppress volatility; they cannot manufacture dollars or eliminate underlying demand.

There is an important distinction between a stable currency and a currency whose stability has to be engineered. The rupee’s recent recovery suggests that the RBI’s stepped-up intervention and tighter foreign-exchange regulations have gained some traction. Yet the accompanying surge in forward premia, widening bid-ask spreads and impaired price discovery tell a less reassuring story. The spot market may look calmer, but the underlying demand for dollars has not disappeared. Much of it has simply migrated elsewhere. Essentially: Squeeze spot demand, and forwards reflexively take the strain.  

That distinction matters. India’s currency defence is increasingly being tested not just by the level of the rupee, but by the growing cost of keeping it stable.

A calmer spot market, a more dysfunctional forward market
The rupee has rebounded by over 2% from its recent low of ₹96.85 per dollar, following a series of RBI measures aimed at containing depreciation and curbing speculative positioning. These followed the early closure of the FCNR(B)+ deposit mobilisation window, which attracted gross inflows of more than $144 billion.

Yet substantial inflows have not eliminated currency pressure. The RBI has continued to intervene in both spot and forward markets, while regulatory restrictions have altered the channels through which dollar demand is expressed.

The resulting stress has been most visible in the forward market. Within barely 10 days of the new measures, the one-month onshore forward premium jumped by around three percentage points to nearly 8%. Three-month and six-month premia also rose sharply, inverting the forward curve. Exceptionally wide bid-ask spreads pointed to thin liquidity and deteriorating price discovery. The inversion of forward curve, signals acute near-term distortion, likely also reflecting importers shifting to shorter-tenor hedges in anticipation of the measures being withdrawn once conditions normalise.

The Foreign Exchange Risk Reserve, or FERR, imposed on eligible rupee derivative contracts exceeding $2 million, has added an estimated 1%–1.5% to the all-in cost of hedging. Restrictions on rebooking cancelled contracts and the reduction in the threshold for transactions without established underlying exposure have further constrained market access.

Some of this repricing is intentional: making hedging more expensive can discourage speculative positions. But the speed and scale of the adjustment reveal the unintended consequences of tightening regulations in an already stressed market. The market response has proved more complex: if importers fear further market curbs or a sharper rupee adjustment, a precautionary rush for forward cover could push premia higher still and reinforce self-fulfilling depreciation expectations.

When policy changes the price signal
Under normal conditions, forward premia are anchored by interest-rate differentials through covered interest rate parity. That relationship becomes less reliable when market access is restricted, arbitrage is impaired and dealer balance sheets are constrained.

The recent surge in premia has far exceeded what interest-rate differentials alone would suggest. Forward pricing is increasingly reflecting liquidity shortages, one-sided positioning, regulatory uncertainty and the cost of securing dollar cover.

This is the central paradox of the RBI’s strategy. Restrict dollar access in the spot market, and demand can spill into forwards; make forwards more expensive, and importers may rush to hedge before conditions tighten further.

The response can become self-reinforcing. If businesses fear a sharper rupee adjustment or additional restrictions, they may seek precautionary forward cover. That pushes premia higher, raises the cost of imports and hedging, and reinforces expectations of further depreciation. Thin liquidity amplifies every move.

The recent easing in premia should therefore be interpreted cautiously. It likely reflects a partial unwinding of the initial panic premium as banks and market participants adapt to the new framework—not a decisive improvement in underlying currency fundamentals. Another bout of dollar demand, wider interest-rate differentials or renewed regulatory uncertainty could trigger fresh volatility.

Nor does the RBI have unlimited capacity to smooth the forward market. Its net short forward book has already exceeded $200 billion, substantially reflecting FCNR-linked swaps. Adding materially to future settlement obligations simply to suppress forward premia would carry its own costs.

Stability today, vulnerabilities tomorrow
The broader question is whether these measures can deliver a durable defence of the rupee. The answer is: only temporarily.

Regulatory restrictions can change the timing and location of dollar demand, but they cannot eliminate the demand itself. If spot purchases become difficult and hedging prohibitively expensive, pressure may reappear through derivatives, offshore markets or renewed spot buying once restrictions ease.

To be fair, rupee’s pain stems partly from an exogenous shock. Services exports continue to cushion the current account deficit, but with BoP pressures increasingly capital account driven, significant short-term rupee deviations from equilibriums are likely. Exchange rates may track fundamentals over the long run, but they can deviate sharply from equilibrium when global risk aversion and capital flows dominate near-term price formation.

India also faces some persistent vulnerabilities. First, the oil import bill is relatively inelastic, leaving the balance of payments exposed to an adverse energy shock. Second, the FCNR(B) inflows that helped bolster dollar availability are liabilities that will eventually need to be repaid. Third, the RBI’s enlarged forward book creates future settlement obligations even as intervention provides near-term relief.

If Brent averages around $100 per barrel, we estimate the 2026-27 CAD/GDP deficit could widen to 1.7%, compounded by elevated electronics imports. With the FCNR window closed and durable capital inflows less certain, we estimate a potential balance-of-payments deficit of about $55 billion-$60 billion in the second half of 2026-27, sustaining depreciation pressure. This would imply that for the whole year BoP is largely neutral, despite a super successful FCNR scheme!

These are not problems that FX market restrictions can resolve. They require durable capital inflows, stronger external resilience and an exchange rate capable of absorbing at least part of the shock.

The monetary policy trade-off getting costlier
The danger is that currency defence gradually constrains the RBI’s broader policy choices. Tighter rupee liquidity and a reluctance to provide ample liquidity support can help contain pressure on the exchange rate, but they also risk tightening domestic financial conditions. If global conditions stay adverse, monetary policy defence could become increasingly costly and hostage to a staunch FX stance. The trade-off between currency stability, banking-system liquidity and monetary-policy flexibility will become harder to manage.

A 2013-style interest-rate defence is no longer remote if global conditions deteriorate further. But the analogy comes with a caveat: raising rates may support the currency by improving relative returns and discouraging outflows, yet its efficacy is uncertain when the market is dislocated and the shock is driven by external risk aversion, oil prices and capital flight. The domestic growth and opportunity cost could also be substantial.

The policy objective, therefore, should not be to defend a particular exchange rate level at any cost. It should be to prevent disorderly movements while allowing prices to transmit information about underlying economic conditions.

The rupee’s recent recovery offers some breathing room, but it should not be mistaken for restored confidence. The test is whether forward premia normalise alongside improving liquidity and durable capital flows — not merely whether spot USD/INR remains contained.

The RBI can buy time by managing the market. It cannot buy durable currency stability without addressing the forces driving the demand for dollars. Greater exchange-rate flexibility, stronger capital inflows and structural reforms remain essential. Otherwise, today’s engineered calm risks giving way to a more expensive defence tomorrow.