The Indian central bank seems to be in crisis-fighting mode. It has dusted off the playbook it last used during the 2013 taper tantrum to ward off a free fall in the currency. But the more desperate the defense of the psychologically important level of 100 rupees to the dollar, the greater the risk that authorities will overplay their hand and cause serious damage.

First, the Reserve Bank of India nudged banks to borrow $133 billion from the diaspora in under three months. When that drive, which ended in August, failed to turn bearish sentiment, the authority last weekend raised lenders’ currency hedging costs and directed oil importers to buy dollars from the RBI, bypassing the market exchange rate.

For now, the rupee has strengthened to around 95 to the dollar. But with turmoil in the Middle East keeping Brent crude above $100 a barrel, food prices pushing inflation to a two-year high, and surging US bond yields sucking capital out of emerging markets, this rescue may be short-lived.

It’s worth remembering that much of what was tried in the panic of 2013 — after the US Federal Reserve signaled an end to the post-Global Financial Crisis cheap money era — went badly wrong. So much so that the market began to ask if the then outgoing Governor Duvvuri Subbarao’s final move would be capital controls. It was only when Raghuram Rajan, a former International Monetary Fund chief economist, took over and announced a committee to anchor monetary policy in explicit inflation targeting that the central bank finally began to recoup its credibility. The pressure on the rupee ebbed.

Therein lies the solution to the current crisis: credibility and adequate risk compensation to global investors. Of late, the RBI has been too accommodative of New Delhi’s fiscal needs — and too hesitant on inflation. After Governor Sanjay Malhotra took over in December 2024, the central bank slashed borrowing costs by 125 basis points and bought more government bonds in 12 months than during the first year of the pandemic. The first 25 basis-point increase in rates came only this month, and even then two out of six policymakers voted against changing the monetary stance to calibrated tightening from neutral.

A course correction must begin by recognizing that the rupee’s defense can’t be left to unconventional measures while regular policy tools gather dust. India’s vast diaspora is undoubtedly its ATM — always ready to oblige when their home country needs hard currency. But this is expensive money. Lenders only raise these dollar deposits because the RBI absorbs the exchange-rate risk on the principal amount. Rajan gave this backstop reluctantly. The $26 billion mobilized back then stabilized foreign reserves.

This time, not only is the amount five times larger, but it’s failing to shore up reserves, which have fallen by $50 billion since early September. Add to that a negative dollar forward book of $200 billion — the RBI’s future obligations — and the $734 billion war chest looks even less impressive. While lenders’ currency risk on principal repayment has been taken over by the RBI, they must still access hard currency for interest payments to diaspora depositors. That exposes banks to an estimated $35 billion in forward dollar demand in present-value terms, according to Observatory Group analyst Ananth Narayan, a former banker and securities regulator.

As it happens, the RBI on Monday imposed fresh restrictions on banks hedging not just their customers’ currency liabilities, but also their own. That’s overkill. In the summer of 2013, a flailing RBI similarly tinkered administratively. Some economists are already urging Malhotra to repeat that experiment in its entirety.

Would that be wise? By hiking overnight rates by 2 percentage points in a single shot, the RBI pushed short-term rates to 10.25% in July 2013. That triggered a working-capital scramble, yielding banks a quick quarter of high-cost loans before sending them into a multi-year tailspin as overleveraged corporate borrowers failed.

After a long wait, credit demand in India has once again strengthened to almost 20%. A big chunk of it is for personal loans. Corporate borrowing is not for new assets, but largely for holding inventory as inflation pushes raw-material costs higher. A bump to short-term rates now would invert the yield curve, destroy banks’ margins, and seize up the credit engine again. Such a move would also short-circuit the monetary-policy committee and diminish its importance.

A cleaner solution may be for the RBI to sell bonds to banks, lifting the entire yield curve rather than just the short end. The 10-year yield tracks banking liquidity closely; mopping up the surplus is the surest way to reset long-term rates. The priority should be to let India rebuild its depleted yield advantage over US Treasuries. The 10-year spread that used to be 600 basis points in 2013 has narrowed to about 200. Without adequate risk compensation, global capital won't arrive.

Forcing the government to borrow at higher rates just when El Niño-induced droughts demand more spending on rural livelihoods may worsen India’s chronic fiscal fragility. But the RBI has done enough already for New Delhi. Its most crucial goal is to regain investors’ trust. The battle of 2013 was won not by unconventional policy tools — but by re-establishing the RBI’s credibility. Even now, there’s no shortcut around it.