Expect more funky moves from RBI

RBI's direction to banks to cap their foreign exchange positions at $100 mn is a signal that the central bank may be open to other forms of capital controls. Unwinding by banks has thrown up arbitrage opportunities for companies between onshore spot market for dollars and forwards market. This limits rupee's ability to recover, unless RBI draws up a broader fence around the demand for dollars. Uncertainty in the energy market will keep demand for dollars elevated, and more unconventional moves by RBI can't be ruled out. Although it's premature to speculate whether the central bank might consider special schemes to raise dollars from India's large pool of overseas workers.

Rupee's decline in March has been unusually severe, and RBI is drawing on its emergency playbook to stabilise the currency. Impact of higher energy prices on India's economic outlook is yet to be determined. Foreign portfolio investment-selling has intensified since US-Israel war on Iran broke out. RBI's intervention to steady the rupee has run into strong dollar demand from energy importers. The directive to banks to cut back their dollar holdings will contribute to market volatility because of large open positions and short window for unwinding.

Rupee has logged its worst yearly performance in over a decade on US tariff action and the Persian Gulf crisis. Central bank intervention is likely to slow the decline. But the underlying pressures will persist as inflation spikes globally and the world economy tilts towards a recession. RBI has managed to keep rupee a 'middle of the pack' performer since hostilities began. Maintaining its place may become tougher if the conflict widens.