By Manish Bhandari, CEO and Portfolio Manager, Vallum Capital
RBI’s decision to hold rates at 5.25% and defend the Rupee through capital account liberalisation rather than cyclical rate hikes is the most analytically defensible decision in the cohort. The logic is sound: in a world of “higher for longer” US rates, India cannot win a rate war without triggering a domestic recession. Raising rates to, say, 7.00–7.50% to arrest a currency decline that is fundamentally caused by a physical energy supply shock would crush credit growth, hurt consumption, and damage the very growth story that anchors the medium-term India thesis. The RBI Governor explicitly communicated — that this depreciation is externally driven (energy shock + Fed hold) rather than domestically generated (fiscal excess, inflation spiral). This framing matters enormously: it provides the policy rationale for holding rates rather than hiking, and it is empirically correct. The pass-through from the INR depreciation to core domestic CPI has remained “benign” precisely because wage growth and domestic demand haven’t accelerated. Raising rates aggressively against this backdrop would be a category error — fighting a supply shock with demand destruction and we agree with that.
The FAR expansion — opening 15Y/30Y/40Y G-secs to unlimited foreign access and targeting global bond index inclusion — creates permanent, sticky, price-insensitive USD inflows via passive funds. JP Morgan’s inclusion of 29 FAR-designated G-secs in its Emerging Market Bond Index in 2024 demonstrated that index integration is the key mechanism for generating durable foreign demand for Indian sovereign debt. This is qualitatively superior to hot-money FPI equity flows that reverse at the first sign of global turbulence. However, the removal of the 12.5% capital gains tax and withholding tax on interest is a welcome step but will not boost the flows due to rupee depreciation and higher yield offered in the global markets.
At $682bn, India’s reserves remain among the largest in the world and dwarf the situation countries like Indonesia faces. Indonesia’s reserves fell to their lowest level in nearly two years as of March 2026, with forex reserves hitting a three-month low of $151.9bn in February alone. India deploying $17bn in a month is costly but manageable; for Indonesia, the same pace of depletion would be existential. India still has 18+ months of import cover at current burn rates — sufficient buffer to execute the structural reforms before reserves become a credibility concern. The RBI bearing the full hedging cost on 3–5Y FCNR(B) deposits is the India-specific equivalent of Brazil’s FX swap architecture: it uses the central bank’s balance sheet to subsidise dollar importation without physically depleting reserves. If executed at scale, this is exactly the kind of financial engineering that BCB demonstrated works.