India cenbank's FX intervention via forwards may hamper rupee's defence -analysts

16 February, 2023

MUMBAI, Oct 17 (Reuters) - The Reserve Bank of India's (RBI) forex intervention through forward dollar sales instead of an on-spot basis may undermine its effort to boost the rupee, analysts said.

Since last week, the central bank has been intervening in the over-the-counter forward market that lifted the rupee from record lows of 82.6825 to the dollar.

The central bank has been selling dollars in spot and conducting buy/sell swaps to shift the delivery of dollars to a future date.

A buy/sell swap involves an agreement to buy dollars at the spot date and to sell dollars at a future predetermined rate.

The difference between the sell rate and the buy rate is the forward premium.

The buy/sell swaps by the RBI have prompted forward premiums on the rupee to plunge.

For instance, the 1-year USD/INR implied yield or the cost of carry has dropped to a 11-year low of 2.45% from an intraday high of over 3.07% on Oct. 10.

The fall in forward premiums reduces the cost of carrying or holding dollar positions and leads to higher demand for dollar from importers.

For the same level of spot, it is now cheaper for importers to buy dollars for a later date.

"RBI reducing cost of carry while wanting to defend the rupee seems counterintuitive," said Abhishek Goenka, founder and CEO of forex advisory firm IFA Global.

As to reasons the RBI may be selling dollars forward and not on spot basis, Goenka said that the central bank does not want its spot dollar sales to impact banking system liquidity, which is perilously close to getting into deficit.

Another reason could be that RBI would be concerned "about the optics of falling forex reserves making headlines every week", Goenka said.

India's foreign exchange reserves have fallen to $532.9 billion from a peak of $642.5 billion last year.

Last month, RBI governor Shaktikanta Das referred to the divergent views on the exchange rate and the adequacy of India's forex reserves, saying, the RBI does not have any fixed exchange rate in mind and intervenes to curb excessive volatility.

Meanwhile, the fall in premiums also dissuades exporters to sell dollar forward.

"A lower forward premium makes it easier to short rupee and disincentivises hedging from exporters," said Anindya Banerjee, head research - FX and interest rates at Kotak Securities.