The rupee may see better days as RBI eases forward intervention


The foreign exchange market’s forward segment has witnessed an upheaval of sorts in the past two months. The premium expected to book dollars at a future date had soared consistently at first up until March, and then dropped sharply this month. The reason behind this move is one factor that may determine the fortunes of the Indian rupee going forward.

Forward premia have fallen sharply since April because the Reserve Bank of India (RBI) reduced its intensity of intervention in that segment. Having racked up a massive $73.2 billion of outstanding forward contracts until February, the central bank has begun to unwind these, mainly through taking delivery of the dollars.

This outstanding forward position came down marginally to $72 billion in March and analysts believe that April and May would show a sharper fall. Those at UBS estimate that the central bank unwound $12.5 billion of forward contracts in April.

Coming off

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Coming off

This is a signal that the central bank won’t indulge in large interventions in the forward market anymore, analysts said. The RBI details the data on its forex market interventions with a lag of two months.

The RBI’s forex intervention policy including tactical changes such as whether to use the spot or the forward market to intervene is a corollary of its juggling act to manage its oldest problem of the impossible trinity.

At any given point in time, a central bank has to choose between a stable currency, stable inflation and an independent monetary policy. For the RBI, this problem has been exacerbated by the pandemic.

Growth recovery needs interest rates to be low, and liquidity in surplus. A weaker currency is also necessary because that makes exports competitive. That explains the RBI’s forex interventions in the wake of sustained dollar inflows. But when the RBI buys dollars, it adds rupees into the system. To avoid this, the central bank buys dollars at a future date, in the forward market.

What may upset this plan is a rise in inflation and the need for cheaper hedging costs. India being a net importer, a weak rupee adds to inflationary pressure and this is especially true in the present case where much of the inflation is due to a surge in global commodity prices.

“In the current environment, the need for low interest rates and reduced FX hedging costs trump liquidity considerations, allowing more direct spot intervention and an increase in foreign reserves,” explain analysts at Barclays in a note.

The upshot is that the rupee is unlikely to see the central bank keeping up pressure.

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