India's policymakers are currently pursuing multiple objectives simultaneously through market interventions, creating significant challenges. According to reports from Business Standard, the Reserve Bank of India has cut the policy repo rate by 125 basis points to 5.25% with consumer inflation averaging 2% through 2025. Between January 2025 and March 2026, the RBI intervened strongly in bond markets and net purchased a record ₹11.6 trillion of government bonds to inject banking liquidity and support economic growth. Meanwhile, gross central and state government borrowing touched a record ₹27 trillion in FY26, with the RBI's large bond purchases indirectly facilitating substantial government financing while keeping yields low. Currently, policymakers want to reverse negative sentiment on the rupee while using fiscal policy to cushion the impact of higher energy prices and adverse weather on inflation and growth, even as interest rates remain low to support economic activities.
The intervention strategy has created self-reinforcing market pressures, particularly in currency markets. As reported by Business Standard, rupee-dollar interest rate differentials fell to historic lows, with hedging and speculative demand for dollars estimated at $117 billion during FY25 and FY26, surpassing the $75 billion outflow from current account deficit and net investment. This resulted in the rupee becoming one of the weakest-performing currencies globally, despite strong RBI intervention in currency markets. The RBI's subsidised swap window for attracting Foreign Currency Non-Resident (Bank) deposits and foreign-currency borrowing is a cost of pursuing these multiple objectives through market intervention. More recently, higher energy prices have worsened prospects for external and fiscal balance, while a possible El Niño has added risks to inflation and rural demand.
The subsidised swap scheme carries significant financial risks for the RBI. According to Business Standard, if the scheme attracts $50 billion of FCNR (B) deposits and $20 billion of foreign borrowing, the mark-to-market loss on the RBI's swap position could approach ₹64,000 crore at current market prices, besides increasing the RBI's balance-sheet risk. Large Indian banks are raising five-year FCNR (B) deposits in dollars at 6%, with overseas banks willing to lend against the same deposits at around 5%, allowing wealthy NRIs to achieve double-digit leveraged dollar returns against India cross-border risk. Indian banks can further transform the FCNR (B) deposits into clean five-year rupee funding at around 6.4%, below comparable government bond yields. This is not merely an accounting cost - the subsidy is real and will be monetised by participating non-resident Indians, banks and borrowers.
The intervention strategy has created regulatory challenges and market distortions. As reported by Business Standard, lower interest rates and changes to debt-fund taxation in 2023 weakened post-tax fixed-income returns for savers, with discretionary money likely moving overseas through overseas direct investment, financed imports, and equity flows. The RBI's subsidised swap window could create ₹6.6 trillion of rupee deposits, with additional inflows potentially coming from India's inclusion in the Bloomberg Aggregate Bond Index after recent tax changes for foreign bond investors. This creates an endless game of whack-a-mole for policymakers unless circumstances turn fortuitously favorable. Policymakers often consider interest rates, capital flows, and exchange rates separately, but markets do not - intervention in one market inevitably influences outcomes in others.
According to the analysis from Business Standard, a more durable solution may lie in reducing distortions and allowing market-determined prices. The suggested approach includes improving post-tax returns for savers through reducing tax burden on fixed income, which could reduce leakages into overseas direct investment, imports, and excessive equity flows. This fiscal cost may not be large, as tax-sensitive discretionary savings in debt funds, fixed deposits, and bonds is already low due to current tax disadvantages. The analysis argues that instead of offering substantial subsidies to selectively attract foreign savings, policymakers could remove distortions discouraging domestic fixed-income savings, allowing interest rates and exchange rates to be determined more by free market forces. More efficient credit, equity and currency markets could support better capital formation, attract more durable investment flows, and require fewer interventions.
