Imagine buying a five-year fire insurance policy for your factory. You pay the premium. The insurer prices the risk. Both sides sign a contract. A year later, a government regulator — concerned that too many insurers have written fire policies in a particular region — suddenly directs your insurer to reduce its exposure. In response, your insurer cancels part of your cover. Your factory is fine. You have not breached the contract. The insurer has not gone bankrupt. And yet, the protection you paid for has vanished — because the regulator abruptly changed its mind.
Most people would find this deeply unsettling. Yet this is exactly how state intervention works in India’s foreign exchange markets.
Exchange-rate management normally involves the central bank participating in the foreign exchange market. However, in the last few years, the RBI has been using its regulatory powers to manage private actors’ positions in the USD-INR market. On 27 March, the Reserve Bank of India imposed a hard cap of USD 100 million on banks’ Net Open Position (NOP) in the onshore rupee market at the close of each business day. Previously, a bank’s permissible foreign exchange exposure was linked to its capital adequacy.
The new circular overrode this entirely: regardless of a bank’s capital strength, it could no longer carry large directional positions against the rupee. Banks were given until 10 April to comply, which meant many had to unwind existing contracts — contracts that were perfectly legal until the day the circular was issued. Around the same time, press reports indicated that RBI officials had begun seeking information from banks about specific client positions and transactions.
This was not an isolated incident. In 2024, as part of its currency defence, the RBI had similarly directed banks to demonstrate underlying exposure for exchange-traded currency derivative contracts, and to refrain from adding to trading positions against the rupee, which we had written about here.
Four problems with this approach
A pattern is emerging: when a crisis hits, the RBI uses its regulatory powers over banks as an instrument for exchange-rate management. Viewed individually, each such intervention may appear to be a technical measure. Viewed together, they create four distinct and serious problems.
First, they restrict the freedom to manage currency risk. The primary purpose of foreign exchange markets is risk management. Exporters hedge receivables. Importers hedge payables. Foreign investors hedge portfolio exposure. By restricting the contracts through which these actors manage risk, the RBI does not eliminate the underlying risk. It merely prevents private parties from allocating it efficiently. When banks accumulate short-rupee positions, they are not necessarily speculating — they may also be hedging genuine client exposures. Restricting their ability to do so does not make the economy safer. It makes risk management harder.
Second, they create regulatory uncertainty, which may be more damaging than the intervention itself. Markets can adapt to almost any stable rule. What they cannot adapt to is uncertainty about the rulebook. Once market participants see that position limits can be changed overnight, a new risk enters every transaction: not just exchange-rate risk or counterparty risk, but regulatory risk. Will this market still exist next month? Will my counterparty still be allowed to maintain this position? Will reporting requirements change? The cost of this uncertainty gets built into every transaction. Exporters deciding whether to expand capacity, importers negotiating multi-year supply agreements, and foreign investors allocating capital all depend on reasonably stable expectations about the rules. Discretionary interventions disrupt those expectations in ways that persist long after the intervention itself is forgotten.
Third, the damage occurs even when the intervention never materialises. A government that threatens nationalisation every six months but never follows through still deters investment — because firms must price in the possibility. Similarly, once market participants learn that the RBI may ask banks to unwind contracts, investigate client positions, or tighten limits without notice, their behaviour changes. Importers and foreign investors who would otherwise hedge their currency exposure may stop doing so, relying instead on the RBI’s continued intervention to keep the rupee stable. This is dangerous: RBI interventions are unpredictable, and no central bank can successfully manage a currency in a globally integrated economy. The result is that the very firms that need protection from currency risk become more exposed to it, not less.
Fourth, there are broader rule-of-law concerns. The Constitution permits reasonable restrictions on business activity, but reasonableness has traditionally required an identifiable public objective and predictable legal standards. What public objective, precisely, is served by restricting market participants from taking positions on the rupee? The argument that such positions are speculative is not supported by evidence, especially because from 2024 onward the RBI emphasised the establishment of underlying exposure even for exchange traded currency derivatives.
Also read: The rupee’s decline is part of the solution, not the problem
The question that needs to be asked
Most commentary on the RBI’s March 2026 circular has focused on whether the intervention was economically justified. That is a legitimate question. An equally important question is this: Was the RBI justified in using its regulatory powers over banks to manage the exchange rate?
When currency management is done through direct interventions in the foreign exchange market, the RBI bears the cost of its decisions on its own balance sheet. When the RBI sells dollars to support the rupee, it is expressing a view, but it is doing so on its own account, at its own risk. What the March 2026 intervention does is fundamentally different. Rather than participating in the market, the RBI used its regulatory authority over banks to prevent market participants from taking positions it was not in favour of.
The distinction matters enormously. In the first case, the RBI competes in the market. In the second, it constrains the market itself. Banks are forced to unwind existing contracts and incur real financial losses — not because those contracts were imprudent or illegal, but because the regulator changed the rules after the fact. This is a qualitatively different kind of intervention, and it raises questions that go well beyond the economics of exchange-rate management.
Transferring the pain
Restricting banks’ foreign exchange positions does not reduce India’s current account deficit, bring back foreign investors, or lower the price of oil. It simply transfers the pain of rupee depreciation — from the RBI’s own balance sheet, where it belongs when the central bank chooses to intervene, onto the balance sheets of banks and the planning horizons of businesses. That is not a defence of the rupee. It is a tax on economic freedom.
This may deliver a few days of currency stability. But the real cost is more durable and damaging than the problem at hand. It undermines the confidence of private actors that in India, the rules of the game are stable enough to plan, and invest. That confidence, once lost, is far harder to rebuild than any exchange rate.
Rajeswari Sengupta is an Associate Professor of Economics at IGIDR, Mumbai. Bhargavi Zaveri-Shah is the co-founder and CEO of The Professeer. She tweets @bhargavizaveri. Views are personal.
(Edited by Aamaan Alam Khan)