Business Standard: Alternatives to intervention - the case for freer markets, fewer distortions

 (This article appeared in Business Standard on June 23, 2026, link here: https://www.business-standard.com/opinion/columns/alternatives-to-intervention-the-case-for-freer-markets-fewer-distortions-126062201293_1.html )

Stepping in may address immediate pressures, but fewer distortions and freer markets could deliver more durable outcomes

India’s policymakers have increasingly relied on intervention across markets to pursue multiple objectives simultaneously.

 

Currently, they want to reverse negative sentiment on the rupee. Meanwhile, fiscal policy is being used to cushion the impact of higher energy prices and likely adverse weather on inflation and growth, even as government borrowing rises. At the same time, they would like interest rates to stay low to support economic activities.

 

Achieving all this simultaneously is challenging. The Reserve Bank of India’s (RBI’s) subsidised swap window for attracting Foreign Currency Non-Resident (Bank), or FCNR (B), deposits and foreign-currency borrowing is a cost of pursuing these multiple objectives through market intervention. It may not stop here.

 

Instead, reducing distortions and allowing freer markets may offer better outcomes.

 

Cost of multiple interventions

 

With the consumer inflation rate averaging 2 per cent through 2025, the Monetary Policy Committee cut the policy repo rate by 125 basis points to 5.25 per cent. Alongside, between January 2025 and March 2026, the RBI intervened strongly in bond markets and net purchased a record ~11.6 trillion of government bonds. The stated aim was to inject banking liquidity, ensure monetary transmission, and support economic growth.

 

Meanwhile, gross central and state government borrowing touched a record ~27 trillion in FY26. The RBI’s large bond purchases indirectly facilitated the financing of a substantial part of government borrowings while keeping yields low.

 

Policymakers often consider interest rates, capital flows, and exchange rates separately. Markets do not. Intervention in one market inevitably influences outcomes in others.

 

Lower interest rates, alongside changes to debt-fund taxation in 2023, further weakened post-tax fixed-income returns for savers. While banks, insurers and pension funds hold most government bonds and are relatively rate-insensitive, sustained credit growth requires discretionary savings to support fixed-income markets. At prevailing rates, that support was increasingly coming from RBI intervention rather than voluntary savings. Rupee-dollar interest-rate differentials also fell to historic lows.

As a result, discretionary money likely moved overseas through overseas direct investment (ODI), financed imports, and flowed into equities. Over time, persistently large domestic flows kept equity valuations elevated at the margin, reducing the attractiveness of Indian equities for foreign investors.

 

As net flows of foreign capital thinned, financing even a modest current account deficit (CAD) was challenging. Low rupee-dollar interest rate differentials also made it cheaper for hedgers and speculators to buy forward dollars against the rupee. During FY25 and FY26, hedging and speculative demand for dollars was an estimated $117 billion, surpassing the $75 billion outflow from CAD and net investment.

 

The result was a self-reinforcing spiral of rupee weakness, despite the RBI’s strong intervention in the currency market. The rupee became one of the weakest-performing currencies globally, making exchange-rate stability an increasingly important policy objective.

 

More recently, higher prices of energy have worsened prospects for an external and fiscal balance, while a possible El Niño has added risks to inflation and rural demand.

 

The RBI’s swap package is a price being paid to reconcile these interventions. It also reflects the significant premium India appears willing to pay to avoid explicit sovereign foreign-currency borrowing, though the effect in substance is not very different.

 

If the scheme were to attract $50 billion of FCNR (B) deposits and $20 billion of foreign borrowing by banks and public-sector enterprises, 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. This is not merely an accounting cost. The subsidy is real and will be monetised by participating non-resident Indians (NRIs), banks and borrowers.

 

Large Indian banks are raising five-year FCNR (B) deposits in dollars at 6 per cent. Their attractiveness is evident from the willingness of overseas banks to lend against the same deposits at around 5 per cent. This, in turn, will allow 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 per cent, below comparable government bond yields.

 

Regulatory whack-a-mole

 

With multiple interventions, unless circumstances turn fortuitously favourable, policymakers risk playing an endless game of whack-a-mole. Consider what could happen next.

 

The RBI’s subsidised swap window could create ~6.6 trillion of rupee deposits. Additional inflows could accrue from India’s inclusion in the Bloomberg Aggregate Bond Index after recent tax changes for foreign bond investors.

 

More term deposits would support further credit growth at low rates, generating still more money.

 

However, money could face the same problem as before. Post-tax returns on fixed-income investment remain unattractive for discretionary savings, and rupee-dollar rate differentials remain low.

 

Consequently, some money could again move overseas, finance imports, or flow disproportionately into equities, sustaining pressure on the external balance and financial markets.

 

The vulnerability from before the Iran conflict could persist though financed differently.

 

Suggested way forward

 

A more durable solution may lie in fewer distortions and more market-determined prices.

First, policymakers should improve post-tax returns for savers so that interest rates are sustained by markets themselves rather than by intervention.

 

Reducing the tax burden on fixed income offers a clear route to improving returns for discretionary savings without raising interest rates. This could reduce leakages into ODI, imports, and excessive flows into equity.

 

The fiscal cost of this may not be large. Tax-sensitive discretionary savings in debt funds, fixed deposits, and bonds is already low, thanks to this tax disadvantage.

 

Indeed, any revenue forgone from encouraging fixed-income savings may be comparable to the cost of the FCNR (B) swap scheme.

 

Viewed differently, instead of periodically offering a substantial subsidy to selectively attract foreign savings, we could remove distortions discouraging domestic fixed-income savings.

 

Thereafter, policymakers could allow interest rates and exchange rates to be determined more by a free market than by heavy intervention. India’s underdeveloped fixed-income markets should then deepen, while equity markets would be driven more by valuations and risk than by tax considerations.

 

More efficient credit, equity and currency markets could support better capital formation, attract more durable investment flows, and require fewer interventions.