Unhedged Positions – Time for RBI to be more cautious on open risks

It is good to create a product that sells, especially if it sells like hot cakes. However, every aggressive sale has a cost. In the Indian context, several products in the last few years have come at a huge hidden cost in the form of open-ended risk.

The downside of sovereign gold bonds (SGB)

When the SGBs were first issued by the government through the RBI, it looked like a great product. Investors got interest, plus tax relief, and participation in capital appreciation. The open question that the government did not address at that point was; how much higher can gold go? What was manna from heaven for investors became a burden for the government, which had to eventually stop issuing SGBs in February 2024. The massive 70% rally in gold in 2025 pushed the overall burden of the government to around $15-$20 billion in redemption losses and taxes forfeited. It can get worse if gold rallies further!

Building massive dollar short positions

The second unhedged position that the government has created is the massive dollar short position to the tune of $110 billion. The short position doubled in the last 1 year. It looked like a good idea because the rupee depreciation was being capped without depleting the dollar reserves. But that is actually another unhedged risk. Here is why. The dollar short position is a derivative position and has to be unwound, as there is a cost to rolling over the position. When the dollar short position is unwound, it results in hardening the dollar, increasing the losses on the short position. The unwinding of dollar shorts will also tighten the domestic liquidity in the money markets.

Giving assurance on currency risk on FCNR(B)

The third major unhedged position that the government is taking on is the assurance to the Indian banks that RBI will bear the currency risk on the FCNR(B) deposits for the limited window up to September. This period is expected to conservatively attract FCNR(B) deposits of $50-$70 billion. For the NRIs, it is a win-win situation. They are getting up to 7.3% tax-free returns on their FCNR deposits, with the currency risk fully taken care of by the RBI. Ideally, the RBI needs to do back-to-back hedging of such risks. If that is not done and the currency weakens sharply from here, then the RBI has to foot the bill on currency losses. That is, again, an open-ended cost for the government.

A common thread between these 3 open positions

Now, there is a common thread between these three open positions we have spoken about; and that common thread is the value of the rupee. If the rupee weakens; then the rupee gold prices surge, dollar short unwinding becomes more expensive, and the RBI has to foot a big fat bill on its currency risk assurance. In 11 out of the 12 years of the NDA government, the Indian rupee has weakened on an annualized basis, so that remains a potent risk for these three open positions. If the rupee starts to harden, then many of these problems get automatically resolved. But, as we have seen in the past; wishful thinking makes for a wonderful breakfast, but it also makes for an awful supper!