Mumbai: The Reserve Bank of India (RBI) is relying on targeted foreign exchange measures to curb speculation and support orderly movement of the rupee, while keeping inflation control at the centre of its monetary policy. Governor Sanjay Malhotra has emphasised that price stability cannot be achieved without financial stability, highlighting the connection between currency markets and the broader financial system.

In an interview with Moneycontrol, Malhotra said the central bank uses monetary policy primarily to manage inflation, while regulatory, supervisory and macroprudential measures help address risks to financial stability.

His remarks come amid questions about whether the Monetary Policy Committee (MPC) could use interest rate increases to support the rupee, which has faced sustained pressure in the foreign exchange market.

Malhotra said the RBI’s approach involves using different instruments for different objectives, while recognising that financial stability is necessary for monetary policy to work effectively.

Why financial stability matters for price control

Malhotra explained that the RBI cannot achieve its price stability objective without a stable financial system. Financial stability supports the effective transmission of monetary policy, allowing changes in policy settings to influence financial conditions and the wider economy.

The governor reiterated that inflation control remains the primary objective guiding monetary policy decisions. Under the separation principle, interest rates are generally used to manage inflation, while targeted regulatory measures address specific risks in financial markets.

However, the two objectives are interconnected. Instability in the financial system can affect the way monetary policy works, making financial stability an important part of the central bank’s broader responsibilities.

The comments clarify why the RBI may respond to pressure in the foreign exchange market through measures other than interest rate changes. Rather than relying exclusively on monetary tightening, it can use regulations designed to discourage excessive speculative activity.

RBI targets speculative positions in the forex market

The central bank has stepped up measures to manage conditions in the foreign exchange market as pressure on the rupee continues.

Malhotra said the RBI had observed excessive speculative positioning on the buy side of the foreign exchange market. The latest restrictions are intended to discourage such positions and ensure that currency movements remain orderly.

One of the measures cited by the governor is the restriction on rebooking cancelled foreign exchange derivatives contracts. The RBI has also introduced a foreign exchange reserve requirement in response to the speculative positioning it observed.

According to Malhotra, these steps are primarily intended to maintain orderly market conditions and check undue speculative bets.

The RBI has also introduced a dedicated dollar window for state-run oil marketing companies. This measure is aimed at addressing their dollar requirements while helping reduce immediate demand in the spot foreign exchange market.

Together, the steps reflect the central bank’s effort to address pressure on the currency through targeted interventions rather than relying solely on changes to interest rates.

Restrictions on non-deliverable rupee derivatives

In another move, the RBI issued a late-evening notification on Monday restricting non-deliverable rupee derivatives contracts offered to non-residents to hedging purposes only.

The restriction forms part of the broader set of measures intended to discourage speculative activity and support orderly conditions in the foreign exchange market.

Foreign exchange derivatives can be used by market participants to manage currency risks. By limiting the permitted use of the specified contracts to hedging, the RBI aims to distinguish risk management activity from positions that contribute to excessive speculation.

The measures underline the central bank’s focus on addressing specific sources of pressure in the currency market through regulatory action.

Malhotra said the RBI remained committed to doing what was necessary to ensure orderly movement in the forex market.

Rupee gains after RBI measures

The Indian rupee strengthened following the recent measures, according to the figures provided in the report.

On Tuesday, the currency gained 0.5%, making it Asia’s best-performing currency during the session and taking it to a one-month high.

The rupee settled at 95.28 per US dollar, compared with its previous close of 95.78. Its gains over three consecutive trading sessions reached 1.6%.

The movement marked a recovery after sustained pressure on the currency. While the improvement followed the RBI’s measures, the central bank’s broader stated objective remains ensuring orderly conditions in the foreign exchange market.

The recent performance also highlights the importance of monitoring currency movements alongside inflation and wider financial conditions. However, the currency’s recovery does not by itself establish how the rupee will perform in subsequent sessions.

RBI’s interest rate decision and inflation focus

The Monetary Policy Committee raised the policy repo rate by 25 basis points to 5.5% on October 7.

The repo rate is an important monetary policy instrument, and changes to it can influence borrowing costs and financial conditions. Malhotra’s latest comments indicate that the RBI continues to view inflation control as the primary guide for monetary policy decisions.

The governor’s remarks do not suggest that interest rates will automatically be adjusted in response to every movement in the rupee. Instead, they underline the role of targeted regulatory measures in addressing foreign exchange market risks.

The distinction is important because currency stability and inflation management are related but are not identical objectives. The RBI must consider the broader economic and financial implications of its decisions while choosing the appropriate instruments.

What the RBI’s approach means for the rupee

Malhotra’s comments point to a strategy that combines inflation-focused monetary policy with targeted measures to address financial market risks.

Interest rates remain central to the RBI’s approach to price stability, while foreign exchange restrictions and other regulatory measures can be used to discourage excessive speculative positioning.

The governor’s central message is that financial stability is necessary for monetary policy to function effectively. By seeking to maintain orderly currency movements and contain speculation, the RBI is addressing risks that could affect the wider financial system.

The rupee’s recent gains provide an indication of how the currency has moved following the measures, but the longer-term outlook will depend on market conditions and other factors affecting foreign exchange demand and supply.

For now, the RBI has reiterated its commitment to orderly conditions in the forex market while maintaining inflation control as the principal objective of monetary policy.