Explained: RBI’s Systematic Plan to Save Rupee and Why Banks will Bear the Cost

For much of March, the rupee was not just weak, it was being attacked by a market structure that turned every attempt at support into a fresh trade. The currency fell 4.24% in March, its sharpest monthly drop in six years and hit a string of all-time lows as oil prices rose and foreign investors pulled money out.

The Reserve Bank of India’s response was unusually aggressive, but the real story is not that the RBI defended a level. It is that the central bank moved to break a profit machine that was feeding on the gap between onshore and offshore rupee pricing.

RBI’s First Hit

The sequence began with a standard crisis setup. A weak rupee, external pressure and a central bank trying to slow the fall.

On March 27, the RBI capped banks’ net open rupee positions at $100 million by the end of each business day, replacing a system in which positions equivalent to about 25% of capital had been allowed.

The intent was to reduce speculative exposure, force discipline on banks and stop the currency slide from becoming a one-way bet.

But the first move created an unintended detour. When banks cut their own positions, the risk did not vanish, it migrated.

Traders and corporates exploited the mismatch between the onshore rupee market in India and the offshore non-deliverable forward, or NDF, market. When NDFs implied a weaker rupee than onshore prices, players could sell dollars in NDF and buy dollars onshore, pocketing the spread. That does not look dramatic on a screen, but in aggregate it adds dollar demand to the domestic market and blunts the RBI’s intervention.

The result was almost perversely visible. After the first cap, the rupee briefly improved, but the relief did not last.

RBI Fixes the Loophole

On March 30, Reuters reported that banks had been forced to offload dollars domestically while buying in the NDF market, creating a large price gap between the two venues.

Corporates stepped in to capture that spread and the rupee gave back most of its gains, ending that session with only a marginal rise after opening much stronger.

The report stated that the 1-month spread, which usually sits in a tiny 1-5 paise band, had blown out to over a rupee at one point. In other words, the RBI had not stopped speculation; it had relocated it.

That is what forced the central bank’s second move, and this one was sharper. Late on April 1, the RBI barred banks from offering rupee NDFs to resident and non-resident clients, and it also prohibited companies from rebooking cancelled forward contracts.

It further tightened rules so that the market could no longer use derivative “hedging” as a disguise for fresh speculative positioning. The message was plain: if a trade does not correspond to a real underlying exposure, it does not belong in the system.

This is where the RBI’s strategy changed from price support to market redesign. The first action targeted banks’ balance-sheet appetite for rupee risk. The second targeted the bridge between the onshore and offshore markets, which had been giving arbitrageurs a way to keep the rupee under pressure even after the central bank intervened.

Reuters described the earlier positions as a “rupee basis trade,” with bankers estimating that banks had built up around $30 billion to $40 billion in positions. Once the RBI cut off the NDF channel, that trade became much harder to recycle, and the route out of the position became more expensive.

Rupee Bounces Back

The immediate market reaction showed that the RBI had found the weak point.

On April 2, the rupee jumped 1.4% to 93.53 per dollar, with traders saying the new rules forced the unwinding of arbitrage positions and lifted offshore hedging costs sharply above onshore levels.

One-month hedging in the domestic market was reportedly around 30 paise, versus about 80 paise in the offshore NDF market, with the gap widening further for longer tenors. That tells you the central bank’s intervention worked not because it supplied more dollars, but because it made the speculative route expensive enough to collapse.

Banks Bear the Cost

The catch is that someone has to absorb the pain of that unwind, and in this case it is the banking system. Jefferies estimated the losses from the RBI’s clampdown at roughly ₹4,000 crore to ₹5,000 crore, or about $428 million to $535 million.

Foreign banks are expected to bear about 45% of the hit, private banks about 40% and the rest largely sits with state-run lenders.

The larger lesson is more important than the one-day rupee bounce. The RBI has signaled that it is willing to use unconventional, highly targeted controls when it believes market plumbing is overpowering policy.

That may help the currency in the short run, but it also carries a trade-off: tighter restrictions can make the INR market less liquid, more segmented and less attractive for global participation.

For now, though, the central bank has made its choice. Rather than keep paying to defend the rupee with reserves alone, it chose to break the arbitrage loop, even if banks have to absorb the bill.