The Reserve Bank of India (RBI) has built up a $31-billion position in rupee-dollar forwards as a continuous foreign fund inflow has necessitated active intervention by the central bank in the spot market.
Forwards contracts are designed to buy foreign currencies at pre-agreed prices. A buyer has to pay a fee, the forward premium, for the right to buy at that price.
Economists and currency dealers said the RBI action could also be a form of insurance against an outflow of dollars as central banks around the world had begun normalising their easy money policies. In August and September, the markets witnessed outflows from the equity markets, highlighting the need to remain cautious on funds flow.
Foreign investors brought $31.33 billion into India in 2017, of which $22.6 billion has moved into debt. This is almost equivalent to the RBI’s net forward position of $31.13 billion, as of September. Of this, $3.44 billion matures within three months and $28.2 billion within a year. In the more than a year segment, the RBI has a ‘sell’ position of $981 billion.
The RBI’s foreign exchange reserves have swelled to over $400 billion. With the current account deficit at a manageable level, the central bank is building reserves but it is not willing to increase liquidity by outright dollar purchases. The RBI mops up incoming liquidity by buying dollars, releasing an equivalent amount of rupees. This can stoke inflation. Therefore, while buying spot dollars, the RBI also sells them over several tranches and buys dollars in the forwards market where physical delivery is not necessary.
These contracts are also squared off by slowly selling dollars in the forwards market. This helps the central to stabilise the exchange rate as well.
“The RBI does not need to intervene always in the spot market. Whenever it buys or sells in the immediate term forwards market, say one or two months from spot, the market gets a sense of the RBI’s mood and adjusts positions accordingly,” said Satyajit Kanjilal, managing director of ForexServe.
Importers are at present not buying forward premiums while exporters are selling them more than their underlying exports positions would suggest. With a stable or appreciating rupee, importers are not interested in being locked up at a particular exchange rate.
“The RBI now has a problem of plenty. As it intervenes, its forwards position swells,” said Abhishek Goenka, managing director and chief executive officer of IFA Global. He said whenever the rupee depreciated to 65 a dollar, the RBI was squaring off its forwards position. With an appreciating bias to the rupee, the RBI had to keep raising its exposure in the forwards market, he added.
“Some accumulation in the forwards market is a compulsion for the central bank, but some of it could be conscious. It could be a form of insurance in case the fund flow reverses in the next year,” said the chief economist of a private bank. The economist pointed out exporters were overhedging and by being the dominant player in the forwards market, the RBI was controlling forward premiums. Exporters, as suppliers of dollars, earn by selling forward premiums to importers.
“The RBI’s target seems to be the real effective exchange rate (REER) of the rupee. It is closely watching the yen and the yuan and does not want the rupee to be overvalued or undervalued beyond a certain extent,” Kanjilal said. The REER is a measure of the rupee’s relative strength against competing currencies. On a 36-currency basis, the REER was 119.57 now, slightly lower than 119.61 in September. A figure above 100 indicates strength of the rupee.