Policy update
Anushree Khare
Background
History doesn’t repeat itself, but it often rhymes. When the war in West Asia intensified in February 2026, the rhyme was not hard to find. Rising crude oil prices expanded India’s trade deficits. Foreign portfolio investors were leaving the market. And the rupee had dropped approximately 3.9 percent against the U.S. Dollar between February 27th and June 22nd 2026.
With increasing pressure building in the external sector, the Reserve Bank of India left the Repo Rate (The repo rate is the interest rate at which the Reserve Bank of India (RBI) lends short-term funds to commercial banks. It is a key monetary policy tool that helps regulate inflation, liquidity, and economic growth) unchanged at 5.25% while presenting a coordinated package of measures including Foreign Currency Non-Resident Bank [FCNR(B)] deposit swap facilities, liberalised Foreign Portfolio Investors (FPI) limits under the Fully Accessible Route, and tax exemptions on Government Securities designed to attract foreign capital into India. This response had many similarities to another time of extreme external weakness in 2013, when a global shock had also produced a reliance on capital inflows to stabilize the Rupee.
While there are almost 13 years separating the two episodes and they were triggered by completely different events, both illustrate a continuing policy problem: how can one manage external shocks without undermining internal economic growth?
Data: What Occurred
Pressure from the Outside World in 2026
From February 27, 2026 (the day after the conflict began), until June 22, 2026 (exchange rate pressures subsequently moderated as regional tensions began to de-escalate following diplomatic developments between the U.S. and Iran), the Rupee decreased by approximately 3.9 percent versus the U.S. Dollar. Although this pressure existed, India’s foreign exchange reserves remained very healthy at $671.6 billion as of June 12, 2026. These reserves provided India with enough currency to purchase imports for over ten months thus allowing pressure to build without requiring India to sell off any significant amount of its foreign exchange reserves.
Figure 1
In FY26, foreign portfolio investment netted outflows of $16.4 billion compared to inflows of $3.6 billion in FY25. These outflows were caused by a globally risk-averse climate due to the West Asia conflict. Meanwhile, net foreign direct investment increased from only $1.0 billion in FY25 to $6.9 billion in FY26 illustrating that while foreign portfolio investments absorbed much of this year’s shock, foreign direct investment remained relatively stable.
Figure 2
Functioning: Policy Responses by India
The RBI left the Repo Rate untouched at 5.25%, limited by an estimated FY27 inflation forecast of 5.1 percent moving up to 5.9 percent in the third quarter of that fiscal year. On and around June 5, 2026, the RBI and Government jointly released a package of external-sector measures intended to mitigate this financing gap without adjusting the policy interest rate.
Figure 3
Of the seven measures listed above six reduce barriers to foreign capital entering the market: extending access via the Fully Accessible Route for longer-term government securities and sovereign green bonds; eliminating FPI concentration restrictions on non-fully accessible routes; increasing ceilings on Non-Resident Indian/Overseas Citizen of India/Person Resident Outside India (NRI/OCI/PROI) equity investment; a program where RBI covers hedge costs for new FCNR(B) deposits; exempting (Foreign Portfolio Investor) FPIs from taxes on profits earned from buying/selling government securities; and offering low-cost swaps for External Commercial Borrowings (ECB).
From a theoretical perspective this asymmetric policy mix shows selective management of capital accounts within the Mundell Fleming framework and Impossible Trinity (Trilemma). By keeping Repo Rate at 5.25 to manage domestic inflation, RBI did not use price instruments (raising interest rates) to attract foreign investment or defend the currency. Instead the central bank directly lowered country risk premium and net transaction costs for foreign investors by reducing hedging costs, subsidizing tax burdens and easing restrictions. Theory of Covered Interest Rate Parity (CIP) says reducing this premium artificially boosts expected net return on foreign capital without requiring change in benchmark interest rate and closes financing gap while preserving domestic monetary autonomy.
The other measure tightened restrictions by shortening the maximum allowable period before exporters convert their earnings into local currency from a temporary high of fifteen months back to nine months suggesting the measures were a focused financing response rather than broad based liberalization.
Impact
Each of these actions serve the purpose of making it easier and less expensive for foreign capital to access the Indian debt & equity market just as the traditional (repo rate) monetary policy tool is being limited due to inflation risk. The FCNR(B) hedging cost plan is an example of how the RBI is using a similar type of financial product that was also used to stabilize the rupee in 2013, although in different form.
Additionally, this brings up a larger unresolved issue related to the types of capital inflows into India. Although net Foreign Direct Investment (FDI) is returning to growth in FY26, it is still far behind the gross amount, and there is disagreement among economists regarding whether to use the gross or net amount to represent committed investors. On one hand some have pointed to robust gross FDI amounts such as the $15.3 billion recorded in April 2026 alone as evidence of investor confidence. Others see many of today’s inflows as private equity/venture capital, which will eventually be exited. Therefore today’s inflow could be tomorrow’s outflow.
Regardless of which viewpoint prevails, it appears that this year’s external shock has been absorbed by portfolio capital and debt inflows. Therefore RBI focused its policy response on portfolio/debt inflows rather than incentivizing additional FDI.
New Emerging Issues
- Portfolio & debt inflows are much quicker to reverse themselves upon renewed global risk-off periods, whereas long-term direct investments are not.
- While the new policies help alleviate the short-term financing pressures they do not deal with the root cause of the problem. The merchandise trade deficit, which continues to be sensitive to oil price movements, evidenced by the swing in the current account from a -$22.9 billion deficit in FY25 to a -$25.2 billion deficit in FY26.
- Although the difference between gross and net FDI has decreased through FY26, there remains a sufficiently large difference to create true uncertainty in regards to the sustainability of India’s non-portfolio capital base.
Figure 4
Way Forward
The policies announced in June 2026 were designed for their purpose: to reduce immediate pressure on both the rupee and India’s Balance of Payments without changing India’s Monetary Policy Rate. The longevity of these policies depend on elements beyond RBI’s direct influence such as the path of the West Asia Conflict, global oil prices, and effects of monsoons on domestic inflation. Ultimately a more sustainable external position over the medium term would likely be dependent on sustained attention toward the mix of capital inflows into India not merely their magnitude considering that portfolio inflows continue to be the most volatile portion of India’s external funding.
As an overall structure, it is necessary to shield India’s current account deficit from foreign price shocks by expediting the domestic green energy transformation to systematically decrease its dependence on the imports of crude oil. It will be possible to develop capital for renewable energy, electrify transportation through electric vehicles and produce domestically produced green hydrogen so that it can act as a structural hedging strategy by gradually replacing the dollar denominated fuels into locally generated clean energy. Ultimately, decreasing import dependency for primary energy will make permanent the stabilization of the trade balance thus creating less necessity in making emergency changes in the capital accounts at central banks during geo-political emergencies.
References
Economic Division, Department of Economic Affairs, Ministry of Finance, Government of India. (2026, June). Monthly economic review: June 2026. https://dea.gov.in
Reserve Bank of India. (2026). Swap facility for External Commercial Borrowings and overseas foreign currency borrowings. https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=13469&Mode=0
Press Information Bureau, Ministry of Finance. (2026, June 5). Tax exemption for FPI investments in Government Securities. Government of India. https://www.pib.gov.in/PressReleasePage.aspx?PRID=2269169®=3&lang=1
Press Information Bureau, Ministry of Commerce and Industry. (2026, June 19). India-Uzbekistan Intergovernmental Commission meeting. Government of India. https://tinyurl.com/ykwzh2fs
Press Information Bureau, Ministry of Commerce and Industry. (2026, June 3). India-Oman Comprehensive Economic Partnership Agreement. Government of India. https://tinyurl.com/mr2kp89k
Press Information Bureau, Ministry of Commerce and Industry. (2026, June 17). India-United Kingdom Comprehensive Economic and Trade Agreement. Government of India. https://tinyurl.com/42zx2ezb
About The Contributor
Anushree Khare is a Research & Editorial Intern at the Impact and Policy Research Institute (IMPRI). She holds a B.A (Hons) degree in Economics with Research. Her academic and professional interests lie in the domains of finance, quantitative research, data-driven policy analysis, and business strategy.
Acknowledgement
The author extends sincere gratitude to the IMPRI team for their guidance and support along with the reviewers Mr. Ayan Bordoloi and Ms. Katyayani Sinha for their valuable feedback and insights.
Disclaimer
All views expressed in the article belong solely to the author and not necessarily to the organization.
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