Why in news?

The RBI asked banks to limit their foreign currency exposure to $100 million per day to control the falling rupee, amid rising oil prices and inflation concerns due to the West Asia conflict. Banks must follow this rule by April 10.

However, the move did not stop the rupee from weakening—it fell below 95 per dollar and closed around 94.8, while oil prices stayed above $100 per barrel. The decision has also worried banks, as it may lead to financial losses due to market fluctuations.

What’s in Today’s Article?

• RBI's Currency Cap: Stemming the Rupee's Fall
• Why Banks Are Worried About the RBI’s Forex Cap?
• More Measures Likely if Rupee Weakness Continues

RBI's Currency Cap: Stemming the Rupee's Fall

• RBI introduced a cap on banks' foreign currency exposure to stabilise the sharply falling rupee and protect India's dwindling foreign exchange reserves, both of which have come under severe pressure since the West Asian conflict began in late February.
• The rupee has hit a historic low of ₹94.81 against the dollar — a fall of four per cent since the war started — having successively breached the 92, 93, and 94 levels in March alone.
• What the Cap Does?
  • Previously, banks were allowed to hold net open positions (foreign currency exposure) up to 25% of their total capital.
  • The RBI has now significantly tightened this limit. Banks have been directed to unwind large currency positions by April 10, a move designed to trigger a temporary surge in dollar supply and provide immediate relief to the rupee.
  • Notably, the RBI has shifted its strategy from direct market intervention (selling dollars from reserves) to regulatory tightening — a deliberate move to preserve its forex "war chest".
  • Despite this shift in strategy, the RBI's earlier direct interventions have already taken a toll.
  • Forex reserves have fallen by over $30 billion to $698.34 billion since the conflict began — a significant depletion driven by the central bank's dollar sales to defend the rupee.
• The FPI Exodus: Fueling the Pressure
  • A key driver of rupee weakness has been relentless foreign investor selling.
  • Foreign Portfolio Investors (FPIs) were net sellers on every single trading day in March.
  • Several factors have contributed to this sustained exodus:
    • weakness in global equity markets,
    • the rupee's steady depreciation,
    • fears of declining Gulf remittances, and
    • concerns over the impact of high crude oil prices on India's growth and corporate earnings.
• The Broader Warning
  • While the RBI's move signals heightened concern over currency volatility, it also underscores the fragility in India's external balances amid rising oil prices and capital outflows — a combination that will continue to test the central bank's resolve in the weeks ahead.

Why Banks Are Worried About the RBI’s Forex Cap?

• Banks are concerned about the RBI’s new forex exposure cap due to its quick implementation timeline.
• They have requested a transition period of about three months, as an immediate rollout could force them to adjust positions abruptly, increasing the risk of losses.
• Risk of Large-Scale Losses
  • Banks currently hold large dollar positions, and enforcing the cap quickly may require them to unwind exposures worth $11–15 billion across the sector.
  • Selling at unfavourable exchange rates could lead to mark-to-market losses, affecting their treasury books and reducing profits for the March quarter.
  • The new restrictions could also hurt banks’ earnings by limiting currency arbitrage opportunities between onshore and offshore markets.
  • This would reduce an important source of trading income.
• Broader Market Concerns
  • Stricter domestic rules may shift trading activity to offshore markets, where regulations are looser.
  • This could encourage speculative bets against the rupee abroad, increasing volatility and potentially weakening the currency further.

More Measures Likely if Rupee Weakness Continues

• Market observers believe that if the rupee continues to fall, the RBI may introduce additional measures to stabilise the currency and protect forex reserves.
• Lessons from Past Crises
  • During earlier crises like the global financial crisis and taper tantrum, then RBI Governor Raghuram Rajan used multiple tools.
  • These included attracting foreign inflows through the FCNR(B) scheme, which brought in over $30 billion, offering dollar swap windows for oil companies, and raising repo rates to control inflation and boost investor confidence.
    • An FCNR (B) — Foreign Currency Non-Resident (Bank) — account is a fixed deposit account for NRIs/PIOs to hold foreign currency in India.
• Policy and Regulatory Interventions
  • The RBI also eased rules for foreign investments (FPIs and ECBs) and imposed import restrictions, especially on gold, to reduce outflows.
  • These steps helped increase reserves and stabilise the rupee.
  • If the situation worsens, the RBI still has a range of tools—including attracting capital inflows, tightening monetary policy, and managing forex demand—to support the rupee and strengthen reserves.