Ex-SEBI Official on Falling Rupee, FIIs, and Indian Markets | ft. Ananth Narayan & Monika Halan

ELI5/TLDR

The rupee has fallen hard, and the usual story is “foreigners are leaving.” Ananth Narayan, a former currency trader who spent three years as a SEBI regulator, tells a stranger story: India’s own savers may have pushed foreign money out. By keeping interest rates low and taxing bonds heavily, the system funnels everyone’s savings into stocks. Too much money chasing too few shares makes Indian equities expensive, which makes it a great place for foreigners to sell and a bad place for them to buy. His fix is counterintuitive: let Indians invest more freely abroad and in bonds, and the foreign money will come back.

The Full Story

The plumbing: why a currency moves

Start with the basic accounting. A country’s money flows split into two buckets. The current account is everyday trade: goods you sell and buy, services, and money sent home by the diaspora. The capital account is investment money: foreigners buying factories (FDI, direct investment) or buying shares and bonds (FPI, portfolio investment), plus overseas borrowing.

India usually spends a bit more on imports than it earns on exports, so the current account runs a deficit of roughly 2% of GDP. That hole normally gets filled by foreign investment coming in. Services exports are the bright spot, growing 17% a year in dollars thanks to global capability centres. The ugly spot is physical goods, where the trade gap with China alone crossed $110 billion because India simply can’t make enough of what it consumes.

The alarming new fact is on the funding side:

“For the first time, the year that just got by, we had a negative number across FPI and FDI put together. First time in 25 odd years… Even in 2008, we didn’t see a negative number.”

Net FDI, which was $45 billion of inflows five years ago, collapsed to under $1 billion. So the question that hangs over the rupee is simple: who funds the deficit if foreign money stops arriving? Add oil prices climbing back toward $100 (post an Iran flare-up) and the deficit could widen to a full 2% of GDP again, roughly $100 billion to fund.

Financial repression: the hidden hand on your savings

Here is Narayan’s central, contestable idea. India practises financial repression — a fancy phrase for “the return you earn on safe, fixed-income savings is kept artificially low.” It happens two ways.

First, the RBI leans on the bond market. Last year was extreme: 125 basis points of rate cuts, plus 8.8 lakh crore of bond-buying. The stated aim was to keep cash flowing through the system, not to fund the government, but the effect was the same — interest rates pressed lower than a free market would set them.

Second, taxes. Interest income gets taxed at your full slab rate. So a 7% fixed deposit, taxed at 35-40%, nets you under 5%, which barely beats inflation. Recent tax changes that stripped debt mutual funds of their old advantages made this worse.

“Money tends to go towards equity markets which is seen as the one market where post tax returns can beat inflation on a consistent basis.”

So discretionary savings pile into stocks. The numbers are stark. In FY25, domestic demand for equity paper ran to about 8.8 lakh crore (6.1 lakh crore through mutual funds alone, an all-time high). But the fresh supply of new shares — companies actually raising money to build things — was only about 4.5 lakh crore. Far more money than paper.

The twist: your SIP may be pushing foreigners out

Too much money chasing too few shares does one thing: it lifts prices. Pockets of Indian equity get overvalued. And that, Narayan argues, is exactly what repels foreign capital.

Think of it from a foreign investor’s seat. If Indian stocks are richly priced, it’s a wonderful place to sell and a hard place to buy. Multinationals are cashing out Indian subsidiaries at valuations seven or eight times what they’d fetch at home. One company books 5-6% of global sales in India but 40% of its market cap. So foreign money finds it easier to exit than to enter — which starves the very capital flows the rupee needs.

“Pushing of discretionary money into equity markets far more than the absorptive capacity… in a funny way deterred capital flows to come into the country.”

There’s a second, more technical channel into the currency. To buy dollars a year out, the forward price depends on the gap between rupee and dollar interest rates. When the RBI cut rates hard in 2025, that gap shrank to about 1.5% — a level Narayan hadn’t seen in decades. That made betting against the rupee, or hedging against it, unusually cheap. So cutting rates quietly subsidised bets against the currency.

“In a funny way pushing down interest rates actually incentivized people to bet against the rupee.”

The blinkered committee

The “impossible trinity” of economics says you can’t simultaneously control your interest rates, your exchange rate, and let capital flow freely — pick two. Narayan’s grievance is that India’s rate-setting body, the Monetary Policy Committee, is legally required to stare only at inflation. When inflation fell to about 2%, it cut rates — without weighing what that did to the wobbling rupee.

“RBI has made sure that the bond market is overvalued. Your retail market has ensured that the equity market is overvalued. Now, where do you want me to bring the money in?”

He’s careful to say the RBI does a genuinely good job keeping its two hats — inflation-fighter and the government’s debt manager — separate. He just wants currency stability allowed into the conversation.

The counterintuitive cure: if you love them, let them go

Narayan’s prescription is to intervene less, not more. India’s credit (bond) market is only 65% the size of its equity market — the lowest ratio in the world (the US is 95%, China a wild 310%). The paternalism that keeps bond rates low has, he argues, achieved the opposite of a deep debt market.

His boldest suggestion: raise the cap on how much Indians can invest abroad (the mutual fund overseas limit has been stuck at $7 billion). Counterintuitive when the rupee is near 94, but his logic is elegant. The money doesn’t really leave — you hold rupee units in a domestic fund, and dollars simply shift from the central bank’s reserves into household hands. It gives savers a real outlet beyond domestic stocks, cools the overvaluation, and that is what coaxes foreign money back in.

“If you love them, let them go… they’ll actually come back and they’ll come back in droves.”

He also flags why companies aren’t issuing more shares despite juicy prices: if a boring, stable business is handed a price-to-earnings ratio of 40 or 50, why would its board take the risk of raising capital to build something new? Cheap, easy valuations can actually dull the appetite for real risk-taking.

Derivatives, prediction markets, and crypto

Monika Halan presses him on consistency. He preaches non-interference, yet SEBI cracked down on futures and options. His answer rests on three concerns: 91-93% of retail traders lost money in F&O (far worse than normal); index-option volumes on expiry day ran 800-900 times the cash market, making the system unstable (the tail wagging the dog); and weekly options seemed to add volatility rather than aid price discovery. SEBI’s first move, back in a 2022 working group Halan sat on, was simply the now-ubiquitous “9 out of 10 lose money” disclaimer — “we are not a nanny state.”

On prediction markets like Polymarket (which called Trump’s win when polls didn’t) and on crypto, he applies the same lens. He won’t ban, but wants minimal oversight — for investor protection and against insiders front-running events. On Bitcoin (a ~$2.7 trillion asset class, about a fifth the size of gold, grown from nothing in 15 years), his advice is to stop treating it as a lottery ticket: hold maybe 0.5% if you must, and size it by risk appetite, not by hope.

The bet nobody is making

His closing read on the next 12-24 months is contrarian. Yes, oil and capital flows are real problems. But the rupee already fell from 84 to 94, and the real effective exchange rate dropped from 107 to 90 — a lot of bad news is priced in. Indian equities are still below their September 2024 peak while much of the world hit new highs. And almost nobody he meets is bullish.

“I find very few people who are bullish India. That tells me everybody’s prepared for bad news. Nobody’s really prepared for good news.”

His personal practice, repeated like a mantra: know your risk appetite, build a diversified portfolio across real estate, equities, fixed income, commodities and foreign assets, don’t time the market, and check it maybe once a month.

Key Takeaways

A currency’s stability rests on whether capital inflows (FDI + FPI) fund the current account deficit. In FY25 India’s net FDI+FPI went negative for the first time in ~25 years — the core reason the rupee is under pressure.
Net FDI collapsed from $45 billion five years ago to under $1 billion last year, even as gross FDI stayed high (~$90 billion). Watch net, not gross.
“Financial repression” = safe fixed-income returns kept artificially low, via (1) RBI rate cuts and bond-buying and (2) full-slab taxation on interest income that nets sub-5% real returns.
Repression funnels discretionary savings into equities. FY25 domestic equity demand (~8.8 lakh crore) far outran fresh share supply (~4.5 lakh crore), inflating valuations.
Overvalued domestic equities make India easy to exit and hard to enter for foreigners — so heavy retail buying may itself deter foreign inflows.
Forward currency pricing = spot rate plus the rupee-dollar interest rate gap. Rate cuts shrank that gap to ~1.5%, making bets against the rupee unusually cheap.
The “impossible trinity”: you can’t fix interest rates, fix the exchange rate, and have free capital flows all at once. India’s MPC is mandated to watch only inflation, ignoring currency effects.
India’s credit market is ~65% of its equity market — the lowest ratio globally (US 95%, Germany/Japan/Korea 125-175%, China 310%).
Counterintuitive fix: raising the overseas-investment cap lets dollars shift from RBI reserves to households without truly leaving (you hold rupee units), cooling overvaluation and inviting foreign money back.
India taxes foreign investors on a source basis (withholding + capital gains onshore), an outlier versus the global residence-based norm — a friction worth removing to attract flows.
SEBI’s F&O concerns: 91-93% of retail traders lost money; expiry-day index option volume ran 800-900x the cash market; weekly options appeared to raise volatility.
Contrarian macro read: rupee (84→94) and REER (107→90) have already absorbed much bad news; Indian equities sit below their Sept 2024 peak while global markets hit highs; sentiment is uniformly bearish.

Claude’s Take

This is a genuinely good macro conversation — the kind that’s getting rare. Narayan is a former trader turned regulator, so he speaks the plumbing fluently and, crucially, keeps flagging his own uncertainty (“for every view there’s a counter view”). That intellectual honesty is the opposite of the usual finance-TV swagger, and it’s why the central thesis lands: the idea that retail SIP enthusiasm may be causing the overvaluation that repels foreign capital is non-obvious and well-argued.

Where to keep a pinch of salt. The “financial repression pushes money into equities, which deters FPI” chain is a coherent story, not a proven one — he says so himself. There are simpler explanations for weak flows (global risk-off, a strong-then-weak dollar, US rates, India’s stretched valuations on their own merits). His “let money flow abroad and it’ll come back” argument is elegant but politically a non-starter when the rupee is at 94, and he knows it. And the contrarian-bull close (“nobody’s bullish, so be bullish”) is a sentiment call dressed as analysis — he hedges it heavily, even joking that doing the opposite of his advice tends to make money.

Score: 8/10. Concept-dense, primary-source credibility (ex-SEBI, ex-trader), and it explains real mechanics — current vs capital account, forward pricing, the impossible trinity — without dumbing them down or hyping them up. Loses a point or two because some of the headline claims are admitted conjecture and the format leaves them unchallenged. Worth the time if you want to understand why the rupee moves rather than just that it moved.