Inflows of $144 bn in a matter of weeks should ideally have ensured a good night's sleep for Sanjay Malhotra. Instead, it appears to have become a nightmare. Just when the stage was set for a rally in rupee against dollar - now an all-too-familiar pattern during sudden gushes of the greenback - RBI is having to dust off a playbook it uses only during a crisis.




Suddenly, rupee's weakness is the talk of the town. The money market is swimming in cash. RBI's market operations are not helping interest rates to be aligned with its goals. Inflation is round the corner due to sticky oil prices, El Nino and geopolitical disturbances.




Thanks to 'Operation Midnight' late last Saturday, which imposed restrictions on forex transactions, including a risk reserve requirement, RBI seems to have signalled there are fault lines running under the surface of the economy that's growing at 7.8%. Headline growth has papered over external weakness.




These are not actions of a central bank that believes the external sector is in the pink of health. These may change the timing and cost of funding of external trade, but aren't going to eliminate basic demand driven by trade and capital flows.




While GDP numbers, driven by domestic factors, have been holding up, the external sector has been flashing amber - relentless and a rising CAD. That RBI had to subsidise investors to bring in dollars through special deposits, captures the state of affairs. Bond yields in the US, Japan, France and Germany are soaring to levels not seen in two decades. India, a net capital importer, can't be blind to such developments around the world.




Overseas investors, who took India to top of the EM heap with the highest premium, are queueing up for exit. They have sold shares worth $61 bn since Oct 2024. The economy may be humming but the plumbing needs fixing.




Indian monetary policy framework, which targets inflation at 4% in a +/-2 percentage point band, was born out of the 2013 taper tantrum crisis when ignoring inflation came home to roost. Although MPC brought credibility, it seems to have acquired a blinkered view of inflation and growth, ignoring the role of interest rates on currency.




As far as equities are concerned, experts peddling that PE ratio for Nifty below the long-term average of 21x is attractive may be good enough to lure gullible retail investors, but not global investors. India, without an AI trade, is still at a premium to China, South Korea, Indonesia, Brazil and MSCI EM Index.




Saturday's midnight measures can slow outflows. But what's needed is to draw inflows. Forex reserves adjusted for forward book is about $420 bn, enough to fund 6 mths of imports, similar to 2013. Capital flows are driven by returns, and little else. Global risk-free return - - are yielding 5.36%. The Indian equivalent is at 7.3%. If historical difference of 450 bps is any guide, this setting won't lure funds.




Scope of MPC needs to be widened beyond inflation and growth to include financial stability. Setting rates on the basis of domestic inflation may meet the mandate, but not a correct one. When price of money has been shooting through the roof everywhere, a quarter-point increase and 'calibrated tightening' stance seem afterthoughts.




The colour of FDI is more important than just the FDI. Much of it over the past decade has been in the nature of financial FDI from PE and venture funds, which have a 5-7-yr lifespan. A vibrant market with SIP flows into MFs may have helped them get unseen valuations, but may end up making retail investors the proverbial lambs in a slaughterhouse. GoI needs to prioritise FDI that not only brings in capital to manufacture but also tech, and capital that stays for decades, instead of PE funds that find their way to Haldiram's and diapers-seller FirstCry.




Another thorny issue is taxation. The state may have arguments to retain securities transaction tax (STT), and both long-term and short-term capital gains taxes. But when the need to compete for funds arises, India must be on the same platform as, or better than, its peers.




Rupee may gain in the short run. Last month, US treasury secretary Scott Bessent may have challenged the bond market with his 'I am the house now' line. But the market slid after an initial blip. And that truth about financial markets is universal.