The Reserve Bank of India (RBI) on Thursday abandoned its hands-off approach to the rupee, which on Thursday ended off an all-time low hit earlier in the day.
In a move to temper speculation-led volatility, the central bank took two measures. First, it curbed trading in rupee forwards. Once cancelled, forward contracts could not be bought again, the RBI said. The new rule applies to domestic as well as foreign investors and takes effect immediately. Forwards are agreements to buy or sell assets at a set price and date. The RBI also said forward contracts booked by foreign institutional investors, once cancelled, could not be rebooked.
“Exporters were booking a forwards contract, cancelling it and then rebooking at a better rate, which was contributing to the free fall of the rupee,” said J Moses Harding, executive vice-president at IndusInd Bank. Second, the RBI reduced the amount of open positions dealers can maintain overnight. At present, a company’s board is permitted to fix suitable limits for various treasury functions with net overnight open exchange positions and aggregate gap limits.
Dealers said the impact of lowering the trading limits would be huge because banks would not be able to keep speculative positions open for a long time. “The broad message the RBI is trying to give is that speculative tendencies have to be curbed and genuine demand and supply should be allowed to move the currency rate,” dealers said. In another move to defend the rupee, the central bank sold dollars on Thursday.
Traders said the RBI’s intervention sparked a slew of stop-losses on long dollar positions by market players who had expected the currency, which had plunged to a record low of 54.30 against the dollar, to hit 55 a dollar. The rupee ended near the day's highs of 53.64/65 per dollar, marginally stronger than Wednesday’s close but well above the record low plumbed in early deals.
At present, the RBI permits hedging of currency risks on the basis of past performance (exports or import) for average three years. The company or unit could also take a hedge based on actual performance in the last financial year.
Now, for importers using the past performance facility, the facility stands reduced to 25 per cent of the limit. Importers, who have used the facility in excess of the revised or reduced limit, are barred from making further bookings.
The RBI said forward contracts booked under the facility would be on a fully deliverable basis. The exchange gains emerging from the cancelling of contracts should not be passed on to the customers.
All cash and spot transactions by banks for clients will be done for actual remittances/delivery only. They cannot be cancelled or cash-settled.
In an effort to control the effect of currency derivative deals by FIIs, the RBI banned rebooking of cancelled contracts by overseas portfolio investors. They can, however, roll over contracts on or before maturity.
At present, FIIs are allowed to hedge currency risk on the market value of the entire investment in equity and/or debt in India.
The RBI also said the intra-day open position/daylight limit of dealers should not exceed the existing approved limits. At present, a company’s board is permitted to fix suitable limits for various treasury functions with net overnight open exchange positions and aggregate gap limits.
The reaction from industry and dealers was mixed. Most said they expected the rupee to “settle down” on Friday but a lot depended on other factors beyond the central bank’s control.
Moses Harding, head, global market group, IndusInd Bank, said the restrictions would take out a big chunk of demand from exporters for dollars. As a consequence, the rupee, which has seen volatile movements, could settle between 53 and 54 against the dollar.
Isaac George, chief financial officer, GVK, said though he would like to wait and watch, it would be good if the RBI was proved right on Friday. “We believe these kind of moves should have happened much earlier,” he said.
JSW Group CFO Sheshagiri Rao welcomed the move, saying it was the correct way to curb speculation. "Whatever arbitration opportunity existed between the non-deliverable forward contract market overseas and India -- currently 60 paise to every dollar -- will now go away,” Rao said.
Durgesh Mehta, CFO, Bombay Dyeing, said it was a welcome move for players like his company who did not believe in taking a position and did direct trade.
The guidelines would affect companies that tended to supplement their business profits with speculative gains in the foreign exchange market, he said. But, he wasn’t sure whether these measures alone would solve the problem. “I believe the RBI's move will provide some relief and arrest further decline in the rupee in the next few days. But, these measures alone cannot prevent rupee depreciation in the medium term," Mehta said.
His counterpart in Infosys, V Balakrishnan, said though the guidelines would not affect Infosys, it was a good step to reduce volatility and speculation in the market.