India’s Central Bank Holds Steady, Uses Capital Controls as a ‘Rocket Launcher’ to Cope with Exchange Rate Pressure

Overview

This report analyzes the outcomes and implications of the Reserve Bank of India’s June 2026 monetary policy meeting. The main conclusion is that the RBI maintained the repo rate at 5.25%, preserving a ‘neutral’ stance, in line with Nomura’s and most market expectations. At the same time, the RBI and the government jointly unveiled a comprehensive package of measures to stimulate capital inflows—dubbed a ‘policy rocket launcher’ by Nomura—aimed at addressing the balance-of-payments (BOP) deficit caused by shrinking capital account surpluses and mounting current account deficits (estimated at around $70 billion for FY27). Nomura estimates that initiatives such as the FCNR(B) offshore deposit scheme could draw roughly $40 billion in funds, effectively easing BOP pressures. However, the RBI has raised the bar for future rate hikes, projecting that interest rates will remain unchanged for the foreseeable future, including through the August meeting.

Core views

**Monetary Policy: Neutral Stance** The RBI Monetary Policy Committee (MPC) voted unanimously to keep the policy rate at 5.25% and maintain a ‘neutral’ position. Despite some market speculation that the RBI might raise rates to defend the rupee, Nomura views this decision as a ‘neutral’ hold, with no changes to liquidity-related language and no hawkish signals. **Capital Inflow ‘Rocket Launcher’** To counterbalance external pressures, the RBI and the government announced a suite of measures: 1) expanding eligible government securities for Foreign Portfolio Investors (FPIs), including 15-, 30-, and 40-year bonds as well as green sovereign bonds, while relaxing investment restrictions; 2) increasing equity investment caps for Non-Resident Indians (NRIs) and Overseas Citizens of India (OCIs), extending eligibility to all overseas residents; 3) exempting FPI bond investments from income tax on interest and capital gains; 4) launching the FCNR(B) offshore deposit scheme, under which banks can accept 3–5-year foreign currency deposits, with the central bank fully covering hedging costs until September 30, 2026, and waiving required cash reserve ratios (CRR) and statutory liquidity ratios (SLR); 5) offering preferential FX swaps to public-sector enterprises to encourage additional External Commercial Borrowings (ECBs); and 6) shortening the export receipt settlement period from 15 months back to 9 months. Nomura had previously anticipated such a policy toolkit in its May 14 report. **Potential Impact of the FCNR(B) Scheme** Drawing on historical precedents—from the 1998, 2000, and 2013 “taper tantrums”—Nomura projects that the FCNR(B) scheme alone could attract deposits equivalent to about 1% of GDP, or roughly $40 billion (compared to $26 billion—or 1.4% of GDP—during the 2013 episode). This would help banks bridge deposit gaps, inject liquidity, and swiftly provide USD funding to alleviate India’s BOP deficit. **Significant Revisions to Inflation and Growth Forecasts** For FY27, the RBI sharply raised its inflation forecast by 50 basis points to 5.1% (from April’s 4.6%), projecting 4.7% in the first half and 5.7% in the second half, with core inflation revised up from 4.4% to 4.7%. The central bank also flagged upside risks to these projections. The primary drivers behind the inflation hike include rising retail prices for gasoline and diesel, secondary effects of cost pass-throughs, and monsoon uncertainties. Meanwhile, the RBI cut its FY27 GDP growth forecast by 30 basis points to 6.6% (from 6.9% in April), citing downside risks stemming from higher commodity costs, supply-side disruptions, weak monsoons, and heightened global market volatility. **Nomura’s Outlook: Rate Hikes Are Not Imminent** Despite significant upward revisions to inflation and downward adjustments to growth, Nomura argues that the RBI’s decision to leave rates unchanged effectively sets a high threshold for future policy moves: with inflation already at 5.1%, further rate hikes would require substantially higher inflation levels. The RBI’s litmus test for tightening remains whether supply-side shocks escalate into broad-based inflation. Nomura agrees with the RBI’s assessment that the risk of supply-side shocks turning into sharper demand-side slowdowns is rising, prompting concerns about premature rate hikes undermining growth. Accordingly, Nomura maintains its prediction that the RBI will not raise rates in the near term—at least through the August meeting. **Interest Rate Strategy** Nomura recommends adopting a “flattener” strategy on the ND-OIS curve, shifting from Sep IMM 1s5s to Sep IMM 2s5s to improve negative carry and valuation. Front-end rates are expected to remain elevated due to inflationary pressures and exchange-rate risks. Although treasury bonds benefit from tax exemptions (on withholding tax and capital gains tax), Nomura doubts these measures will lead to meaningful capital inflows or yield declines, as FPI investors remain primarily concerned about exchange rates, hedging costs have yet to drop significantly, and FAR limits (foreign portfolio investment caps) remain largely unused. Fiscal risks remain high, potentially pushing Indian interest rates higher.

Analysis framework

The report employs a standard macroeconomic policy analysis framework, integrating cross-cutting perspectives across monetary policy, balance of payments, exchange rates, and capital flows. The core logic proceeds as follows: First, it identifies India’s primary challenge as a balance-of-payments deficit—rooted in shrinking capital account surpluses combined with mounting current account pressures—rather than overheated domestic demand. Consequently, the RBI opts for non-interest-rate tools—capital inflow management instruments—instead of raising rates to defend the rupee. Second, Nomura evaluates the potential impact of new policies by reviewing historical precedents—such as the FCNR(B) scheme during the 2013 taper tantrum—and conducting quantitative estimations—projecting roughly $40 billion, or 1% of GDP. Third, leveraging the RBI’s apparent divergence between hawkish data (inflation revision upward) and dovish action (no rate hike), Nomura dissects the underlying policy rationale: the RBI prioritizes mitigating growth downside risks and imposes a high threshold—“generalized supply shock”—before considering rate hikes. Finally, drawing on the RBI’s verbal cues and forward guidance—which emphasize data dependency and waiting for clearer signals—the report derives the central prediction of “no rate hikes for the year.” In the interest rate strategy section, fixed-income analytical tools such as curve trading (flatteners) and beta coefficients (measuring exchange-rate sensitivity to interest-rate curves) are employed.

Methodology notes

• Macroeconomic frameworkCredit/debt cycle

  External Imbalance (BOP Deficit) Analysis

  The report frames India’s current predicament as a balance-of-payments imbalance—characterized by shrinking capital account surpluses and mounting current account deficits—rather than domestic inflation overheating. This distinction serves as a critical premise for selecting policy tools—managing capital inflows instead of raising rates. Such differentiation between internal and external imbalances represents a key analytical approach for understanding emerging-market central-bank responses.

• Industry/ Sector Analysis FrameworkSupply-demand framework

  Supply Shock vs. Demand Slowdown

  The report examines whether supply-side shocks—high commodity prices, supply-chain disruptions, and monsoon-related issues—could propagate into broader inflation driven by demand. It concludes that there exists a risk of supply shocks evolving into more pronounced demand-side slowdowns, forming a crucial analytical lens for assessing central-bank policy directions.

• Cycle and Economic Conditions FrameworkTurning Point Analysis

  Threshold Effect in Central-Bank Policy Response

  The report argues that by revising inflation forecasts upward to 5.1% while keeping rates unchanged, the RBI has effectively raised the threshold for future rate hikes: only much higher inflation levels would trigger action. This reflects the concept of a ‘hawkish threshold’—using worse-than-expected economic data to avoid immediate rate hikes.

• Event Game Theory and Behavioral FinanceExpectation Gap/Expectation Management

  Central-Bank Forward Guidance and Market Expectation Management

  The report analyzes how the RBI manages market expectations by maintaining a ‘neutral’ stance and anchoring its tightening litmus test to ‘generalized supply shock.’ Originally, markets feared rate hikes; however, the RBI’s actual actions—holding rates steady and implementing capital-inflow measures—created an unexpected dovish effect.

• Fixed-Income and Credit AnalysisDuration/Convexity Analysis

  OIS Curve Trading Strategy

  The report advises flattening the OIS curve—betting on short-term rates rising faster than long-term rates—as short-term rates face greater exposure to inflation and exchange-rate risks. Adjusting strategies—from 1s5s to 2s5s—reflects trade-offs between negative carry and valuation, embodying typical relative-value trading approaches in fixed-income markets.

Key data

• RBI Repo Rate5.25%MPC unanimously agreed to keep it unchanged, maintaining a ‘neutral’ stance
• RBI FY27 CPI Inflation Forecast5.1%Upgraded by 50 bps from April’s 4.6%; projected 5.7% in the second half
• RBI FY27 Core Inflation Forecast4.7%Raised by 30 bps from April’s 4.4%
• RBI FY27 GDP Growth Forecast6.6%Downgraded by 30 bps from April’s 6.9%
• Nomura’s Estimate of FY27 BOP DeficitApproximately $70 billionProjected before the introduction of capital-inflow measures
• Nomura’s Estimate of Capital Inflows Attributable to FCNR(B) SchemeAbout $40 billion (roughly 1% of GDP)Based on historical experience from similar schemes in 1998, 2000, and 2013
• RBI FY27 Inflation Forecast (Nomura vs. RBI)5.0%Nomura’s estimate slightly lower than RBI’s 5.1%
• RBI FY27 GDP Growth Forecast (Nomura vs. RBI)6.6%Consistent with RBI’s projection
• FY26 Q4 Actual GDP Growth7.8% y-o-yHigher than market expectations (7.3%) and Nomura’s forecast (7.4%); however, seasonally adjusted quarter-on-quarter growth slowed from 1.8% to 1.5%

Impact & implications

The report suggests that the RBI’s ‘policy rocket launcher’ has successfully eased market concerns about rate hikes aimed at defending the rupee—a move consistent with the RBI’s reputation as a conventional central bank operating within an elastic inflation-targeting framework. By managing external pressures through non-monetary means, the RBI has helped stabilize market expectations regarding the rupee exchange rate. On the interest-rate front, Nomura anticipates that short-term rates in India will remain elevated, constrained by CPI trends and exchange-rate risks, while fiscal risks continue to push overall interest rates higher. Therefore, the report advises against investing in government bonds—even with tax breaks—and recommends continuing the strategy of flattening the OIS curve. For the banking system, the FCNR(B) scheme offers relief from deposit shortages and helps inject liquidity.

Risks

• Supply-side inflationary shocks spreading into widespread second-round effects via expectations and wage channels, forcing the RBI to tighten policy.
• El Niño or insufficient monsoon rains leading to unexpectedly high food inflation, despite historically unstable correlations between rainfall and inflation.
• Heightened global economic volatility weakening external demand and impacting Indian exports and growth.
• Persistently high fiscal risks potentially driving Indian interest rates higher.
• The scale of capital inflows attracted by the FCNR(B) scheme falling short of historical performance—only 1% of GDP versus 1.4% in 2013.
• Continued depreciation pressure on the rupee failing to be adequately alleviated by capital-inflow measures, reigniting market skepticism about the central bank’s credibility.

What to watch

• Details of the FCNR(B) scheme and its actual effectiveness in attracting deposits.
• Quarterly CPI inflation trends in India, particularly whether Q3 (October–December) reaches Nomura’s projected 5.5% (versus RBI’s 5.9%).
• Progress of the monsoon season and its impact on agricultural commodity prices.
• The outcome of the RBI’s next meeting in August and any policy moves taken.
• Trends in international commodity prices—especially energy and input goods—and their transmission to core inflation.
• Changes in hedging costs faced by FPI investors and whether RBI’s relief measures have significantly reduced them, thereby encouraging bond inflows.