Spare cash in India's banking system has shrunk fast as the Reserve Bank of India defends the rupee, and the overnight call rate averaged 5.75% on Oct. 27, the ceiling of the RBI's policy corridor. The net cash the RBI absorbed from lenders through its daily operations fell to INR 304 billion that day from INR 2.44 trillion on Oct. 12, central bank data show.

For investors across Asia, the squeeze shows what currency stability is costing India. The call rate now sits a quarter point above the 5.5% repo rate the RBI set three weeks ago, while foreign investors have sold about US$8.5 billion of Indian equities over the past two months, Reuters reported. In August, when cash was plentiful, the call rate averaged about 5.14%, below the 5.25% policy rate then in force, according to IDFC First Bank.

The rupee is sliding again. It closed at 95.22 per dollar on Wednesday, Oct. 28, weaker than Tuesday's 95.1150, Reuters reported, edging toward 95.30, a level traders had flagged as near-term support. Intervention and the new curbs helped it recover earlier this month after it came close to its record low of 96.96, set in May, according to Reuters.

What Is Draining Cash From India's Banks

Dollar sales are one channel. When the RBI sells dollars, banks pay in rupees that leave the system, the mechanism it used in September to drain cash through currency swaps, Bloomberg reported. The RBI has spent around US$80 billion supporting the rupee since June, according to Reuters. India's foreign exchange reserves fell US$5.0 billion in the week to Oct. 16, to US$721.0 billion, the RBI's weekly statistical supplement showed.

Other drains are at work. The same RBI data show it sold INR 250 billion of bonds on Oct. 14, and currency held by the public rose INR 485 billion in the first half of October. IDFC First Bank analysts said this month that bond sales, dollar sales and swaps had all withdrawn durable liquidity, Reuters reported.

New hedging rules also lock up cash. Under an Oct. 10 circular, banks must hold a Foreign Exchange Risk Reserve equal to 20% of the notional value of rupee derivative contracts above US$2 million in which clients buy foreign currency to hedge current-account transactions. An Oct. 12 circular extended it to contracts in which banks buy foreign currency to hedge their own assets and liabilities. The reserve must be kept in cash at the RBI until each contract ends; the RBI said it was meant to keep the currency market orderly.

The RBI also barred clients from rebooking cancelled rupee hedges and cut to US$5 million, from US$100 million, the positions users can take without proving an underlying exposure. Non-deliverable rupee contracts for nonresidents are now limited to hedging.

The money market has turned quickly. On Oct. 8 the RBI was still draining cash through a 29-day reverse repo. Since Oct. 19 it has been adding funds through repo auctions: INR 1 trillion for seven days that day, then a four-day, INR 1.5 trillion operation on Oct. 26 that drew bids of INR 1.87 trillion and cleared at 5.55%.

The reversal follows a record. Surplus bank liquidity reached about INR 11 trillion in early September after inflows attracted by RBI measures topped US$140 billion, Bloomberg reported.

Oil, Outflows and the Fed Weigh on the Rupee

Oil is a major strain. Brent crude hovered near US$117 a barrel in Asian trading on Oct. 27, close to a six-month high, and India imports about 90% of its oil, Reuters reported. A special RBI window lets refiners buy dollars directly, keeping some of that demand out of the open market.

High U.S. Treasury yields, with the 10-year around 5%, leave too little extra return for holding rupee assets, traders and investors told Reuters.

The Federal Reserve offered no relief. It held its target range at 3.75% to 4% on Oct. 28 in a 10-2 vote, with both dissenters favoring a quarter-point increase, and said inflation "remains elevated." ING analysts expect a December hike, Reuters reported.

That leaves India's repo rate 1.5 percentage points above the top of the Fed's range. Saugata Bhattacharya, a Mumbai-based economist on the RBI's Monetary Policy Committee, wrote in minutes published Oct. 21 that keeping a gap between Indian and Group of Seven interest rates matters for attracting debt inflows.

Across Asia, the rupee is among the weaker currencies this year, though not the weakest. The dollar has gained about 6.1% against it and 8.8% against Indonesia's rupiah but has fallen 6.8% against South Korea's won, Trading Economics data showed late on Oct. 28, reflecting a split between chip exporters and oil importers across the region's currencies.

What Traders Expect From the RBI

Traders say the open question is how much weakness the RBI will accept. State-run banks sold dollars on Oct. 27, possibly on the central bank's behalf, two traders told Reuters, helping the rupee recover after it slipped to 95.24.

Former RBI Governor Raghuram Rajan told Reuters on Oct. 27 that India should not "fixate on a number" for the currency or run down reserves to defend it.

The cash cushion may thin further. IDFC First Bank projected in August that core liquidity would fall to INR 5.4 trillion by March 2027, with 76% of the fiscal year's cash withdrawals by the public expected in the second half.

The next tests come quickly. The INR 1.5 trillion repo matures on Oct. 30, the 29-day reverse repo unwinds on Nov. 6, and the Monetary Policy Committee, which signaled with its Oct. 7 increase that rate cuts were off the table in the near term, meets again Dec. 2 to 4.