Above all, the narrow interest rate differentials vis-a-vis the US and expectations of INR depreciation have led to greater importer hedging (importer leads) and subdued exporter hedging (exporter lags). Indian equity markets witnessed FPI outflows of ~$30 billion, in addition to ~$19 billion from last year.
RBI’s headline reserves are ~$685 billion. RBI, due to its FX intervention, has a short forward book of ~$100 billion. Adjusting for this and gold valuation, usable reserves are ~$460 billion.
In the above backdrop, GOI and RBI came up with measures to augment capital flows – removal of withholding tax and capital gains on government bonds, bearing full hedging cost for incremental FCNR (B) deposits, concessional swap window for ECBs raised by PSUs, expansion of bonds to be included in the Fully Accessible Route (FAR) for FPIs, simplifying various investment categories for FPI investment, permitting Persons Resident Outside India (PROI) to invest in Indian equities. These measures will likely bring in capital flows in the region of ~$70 billion.
A similar FCNR (B) scheme was announced in 2013. In September 2013, prior to the FCNR announcement, the INR was 65.70, and the 40-country Real Effective Exchange Rate indicated an 11.50% undervaluation. Following the FCNR announcement in September 2013 until June 2014, the INR appreciated by approximately 10%, moving from 65.70 to 59.10. Consequently, the REER undervaluation corrected to 4.5%. While FCNR was a necessary catalyst for this appreciation, the sufficient condition was an expectation of a stable government in 2014 that triggered capital inflows.
Fast forward to 2026, and the USD/INR was at 95.70 when the recent FCNR announcement was made, with the 40-country REER being ~10% undervalued. The FCNR announcement provides the necessary condition for INR appreciation; the sufficient condition could materialise from an unwind of importer leads and exporter lags, estimated at ~$185 billion.
For FY24-25 and FY25-26, Balance of Payments (BoP) data suggests a net reserve drawdown of ~$29 billion. This number does not fully capture the extent of the RBI’s FX intervention. RBI sold $87 billion in the spot market over these two years, $34 billion in 2025 and $53 billion in 2026. Further, RBI increased its net short USD position in the forward market to $103 billion from a long position of $24 billion in FY23, swinging by $127 billion.Combining the above spot sales and the change in the forward book, which is ~$214 billion, and comparing this to the reserve drawdown from the BoP data of ~$29 billion indicates an unexplained difference of $185 billion. This number highlights intervention to accommodate importer leads and exporter lags.
Will INR appreciate by 10%, like in 2013? Here, INR needs to navigate a short forward book at the RBI (mirror of leads and lags). Also important will be RBI’s intervention reaction function and implications for CNH/INR (INR has depreciated by close to 20% against the CNH since 2025 – to be seen in the context of India running a bilateral trade deficit of ~$100 billion with China). Important for INR appreciation would be an unwind of importer leads and exporter lags.
A suggestion to RBI for solving leads and lags, driven by narrow interest differentials without resorting to increasing policy rates, would be to consider a Cash Reserve Ratio on banks when their importer constituents buy foreign currency through forwards. This FX CRR can be at 20%. At an exchange rate of 94.50/$, this would entail a CRR amount of ~Rs 19 (20% of 94.50), the cost of which will be ~Rs 1.40 (~7.5% interest cost for the bank on Rs 19), which means the forward premium for importer hedging would go up by ~Rs 1.40 as the banks pass on this cost to importers. The current one-year forward premium is 2.85%, which will go up by ~1.50% to ~4.35%. If leads and lags take time to resolve, then RBI can consider progressively increasing the FX CRR ratio from 20%. At incremental CRRs of 40%, 60%, 80% and 100%, the resultant one-year forward premium for the importer would be 5.79%, 7.26%, 8.73% and 10.20%, respectively.
The above should resolve the leads and lags situation, without changing policy rates while providing the sufficient condition to help correct ~10% INR undervaluation. Another benefit would include a substantial reduction in RBI’s short forward position. This measure will lean against unidirectional expectations of a weaker rupee, which has implications for financial stability.
(The author is a Managing Director at Deutsche Bank India)
