The recurring round number skirmish
Business Standard, 31 August 2026
Scripted skirmishes
In Indian currency policy, an odd significance is attached to round numbers. Policy makers resist the market when faced with some multiples of five and ten. The exchange rate is a price, determined by the actions of millions of economic agents. But near many of these round numbers, the government takes a stand, tries to prevent depreciation, and a script plays out:
- The rupee gets more dwell time near the round number, held up with much huffing and puffing by the authorities.
- Many distortions are imposed upon the economy.
- The smart money knows that the market will win.
- There is ample time in which large speculative positions are built up.
- The costs associated with the rupee defence pile up.
- Eventually, the government yields ground.
- The rupee surges past the round number.
- The speculators break out the champagne.
Macroeconomic fundamentals today
How do we assess the macroeconomic fundamentals around the present skirmish? In the domestic economy, the pace of investment activity is cautious. The current account balance is the gap between domestic investment and domestic savings. Because domestic investment is weak, the current account deficit is modest. There is no large financing problem in India that needs to be solved by capital inflows. This situation gives comfort for a strong rupee policy. Some people see the softness of FPI and FDI inflows into India, and sound an alarm for the INR, but that's not a useful line of thought. Weak capital inflows hamper GDP growth but do not matter in this skirmish.
Global conditions point in a different direction. A problem is brewing in the US macroeconomic environment because of interest rate hikes. The 10-year rate in the US has risen from 4 per cent in March to 4.7 per cent today. This reflects the possibility that the US Federal Reserve will raise rates to fight incipient inflation.
Financial markets operate on relative prices. Capital flows across borders based on the difference in yield and the expected change in currency values. When the US interest rate is higher, Indian assets must become cheaper to justify foreign ownership. An exchange rate depreciation is the mechanism through which the market economy achieves this equilibrium.
RBI's war chest
A lot is made of the FCNR(B) war chest. The proposition is that a chunk of foreign money will appear in India, be purchased by the central bank, become ammunition for future currency trading, and postpone the INR depreciation for a few months. The numbers are less impressive than they seem, particularly when seen in the context of RBI's open position on INR derivatives.
India is now a big country. The gross inflows on the current account are at $1.1 trillion a year. On the capital account, there is a gross inflow of $1.7 trillion a year. Put together, we are getting inflows and outflows of about $2.8 trillion a year or about $11 billion a day. A comparison against conditions in the 2013-14 currency defence is instructive. At that time, the gross flows were $0.55 trillion and $0.52 trillion on the current and capital accounts respectively, i.e. $4.3 billion a day. Today's India is 2.6 times bigger.
The FCNR(B) strategem relies on using public money to defend the rupee. The state subsidises foreign borrowing to attract dollars. This tool requires large scale borrowing to make a material difference against a gross external flow of $11 billion a day. A commensurately large fiscal cost falls upon the exchequer. The Ministry of Finance will choose how much it is willing to spend in exchange for this round number.
Many sentient agents that watch for opportunities
The enhanced size of the economy reshapes the size of speculative pressures when compared with the conditions in the taper tantrum. The USD/INR market is not limited to financial firms. It involves everyone engaged in international activities. As the next round number approaches, a large array of clever people reshape their ordinary imports, exports, and capital account activities so as to profit from the depreciation.
For example, a family obtaining remittances might hold its breath at Rs.96, wait till Rs.106 and earn a profit of Rs.10 a dollar. Importers will boost their inventories, and exporters will delay bringing their dollar earnings home. With $2.8 trillion of gross inflow a year, a small shift in such leads and lags make a difference to the USD/INR market which is large when compared with the resources of the authorities.
Those who can will send money out at Rs.96 and turn a profit by bringing it back at Rs.106. As the profit opportunity ripens, more ordinary people will take detours to do a little currency speculation on the side. In the jargon of the Korean market, we're up against `ants'; in the jargon of the Robinhood episode, we're up against `apes'. The costs of rupee defence go up, and dispassionate policy makers will dismantle their barricade sooner.
Skirmishes and economic growth
There is important damage outside the immediate fiscal cost. Financial development in India is retarded by hostile policy actions in each round number skirmish. The Indian state defends the rupee by harming Indian finance. Position limits are reduced. Capital controls are tightened. Regulatory pressure is applied to suppress trading volumes. Liquidity in the onshore currency derivatives market is harmed.
These actions increase the cost of doing business in India. Currency risk management becomes more expensive. When onshore markets are restricted, price discovery shifts to offshore rupee derivative markets. The local financial industry loses business; local users find ways to pay fees to lawyers and accountants to get their orders into the overseas market. The institutional capability of the Indian financial system takes a step backward. Financial market development -- a fundamental input for Indian economic growth -- is hampered in return for a round number.
Currency defence and monetary policy
Three factors now point in favour of higher interest rates in India. The first is inflationary pressures in India after the global oil price hike, which call for an orthodox inflation targeting response. The second is the present round number skirmish: higher interest rates help defend the INR.
The third is higher rates in the US. When the authorities have an exchange rate objective for the USD/INR, there is `exchange rate dominance', they obey the US Fed. They cede their autonomy to pursue the monetary policy that India requires.
A policy proposal
This skirmish will end, as they all do. It would be good to add one last line in the script: Once the round number is breached, policy makers must reverse all the harm done to financial development during the skirmish.
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