Owned or owed? Rethinking India’s forex cushion

Conservation—and even augmentation—of India’s foreign exchange reserves has acquired unusual prominence. The Prime Minister has appealed to citizens to curtail foreign travel, avoid gold purchases for a year and reduce dollar-intensive expenditure, while public sector executives have reportedly been advised to forgo foreign trips.

This represents an interesting application of the “nudge” theory of behavioural economics, popularised by Nobel laureate Richard Thaler. India has seen such nudges before. The Swachh Bharat campaign and the “Vocal for Local” initiative are notable examples.

Whether such appeals influence behaviour in a vast and diverse country is a moot point. But history shows that Indians rally around national causes in times of stress. During the food crisis of 1965, Prime Minister Lal Bahadur Shastri’s appeal to skip one meal a week evolved into the celebrated “Shastri Vrat”. Many citizens reportedly continued the Monday fast long after the crisis had passed. Such campaigns succeed when people perceive an “economic necessity” rather than merely a “moral choice”.

The Prime Minister’s concern appears to be the conservation of foreign exchange, particularly US dollars, at a time when the rupee faces pressure. Foreign Portfolio Investors (FPIs) have been exiting Indian equities, citing elevated valuations. The market’s price-to-earnings ratio, which stood around 23–24 at the beginning of FY 2025-26, has moderated to about 20–21 following sustained foreign selling.

FPIs withdrew nearly US$18 billion during FY 2025-26. More strikingly, the first two months of the current financial year have already witnessed outflows of roughly US$11 billion. Such withdrawals affect the demand-supply balance in the foreign exchange market and weaken the rupee.

External conditions have further aggravated the situation. The US-Israel-Iran conflict, disruptions around the Strait of Hormuz, higher oil prices, uncertainty in US tariff policy and commodity supply disturbances have created the ingredients of a “perfect storm”. The rupee has weakened from around ₹85 per dollar a year ago to nearly ₹95 now, a depreciation of about 12 per cent. This decline has been sharper than that of the currencies of China, Indonesian Rupiah, Bangladesh and Brazil.

The Reserve Bank of India(RBI) has attempted to smooth volatility by selling dollars from its reserves. Such intervention is not merely a reflex; it also signals the central bank’s intentions and discourages speculative attacks. While India’s foreign exchange market remains regulated because of limited capital account convertibility, the offshore Non-Deliverable Forward (NDF) market remains a significant challenge.

The NDF market is essentially a cash-settled wager on the future value of the rupee. Since the rupee is not freely available offshore, contracts are settled by paying the difference between the contracted and actual exchange rates. Although entirely outside RBI regulation, NDF trading influences sentiment because major international banks and traders participate in it.

Interestingly, the RBI itself has not publicly expressed alarm about either reserve levels or the rupee’s movement. In recent speeches (April 18 and May 20), the Governor has not indicated any immediate concern about dollar supply as distinct from the Prime Minister’s public appeal.

India surely requires a clearer forex “strategy” as different from mere tactics.

First, the NDF market should be reviewed comprehensively. If regulators accept NDF trading as legitimate, the case for opposing other speculative instruments becomes weaker. A phased withdrawal of onshore participation in offshore NDF betting deserves consideration. After a reasonable transition period, resident entities could be required to wind down such positions. The rupee movement immediately after the ban (April 1) and the tweaking (April 20) offers us good lessons.

Second, forex reserves should be strengthened through incentivised FCNR deposits. The Government could provide a one-percentage-point interest subsidy on incremental (sic) FCNR deposits mobilised up to an aggregate target of, say, US$50 billion, subject to a minimum tenure of two years. The fiscal cost would be modest—around ₹4,750 crore annually. The Union Budget is nearly ₹50 lakh crore, so this amount can be borne by the fisc. Such a scheme would be easy to roll out and to administer as we are just supporting more accretions to an existing product.

Third, Non-Resident Non-Repatriable (NRNR) deposits deserve renewed attention. These deposits generate foreign exchange inflows without creating future foreign exchange outflows. Incremental NRNR deposits could be exempted from Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) requirements up to a specified amount for the market as a whole, incentivising banks to mobilise them aggressively.

Finally, India should distinguish between the “owned” and “owed” components of its foreign exchange reserves. Current assessments focus on import cover and external repayment obligations on the basis of the total reserves. Yet, in a crisis, the true buffer is what the country actually owns rather than what it owes. Gold holdings constitute a genuinely owned reserve asset; much of the remainder represents liabilities of one form or another owing to NRIs, AIFs (Alternative Investment Fund), debt, etc. Just as the Bimal Jalan Committee developed a framework for capital buffers, there is a case for defining a minimum threshold for genuinely owned reserves. Such a framework alone would provide a more realistic measure of external resilience.