RBI intervenes more through forwards in foreign exchange market

Data released by central bank reveals outstanding net forward purchases stand at $2.59 bn in June

The Reserve Bank of India (RBI) seems to have changed its foreign exchange intervention strategy to more of net purchases of dollars from the forwards route than spot interventions.

The latter was leading to a lot of excess liquidity in the system. RBI data for June shows net forward purchases at $2.59 billion as compared to only $565 million of net purchases of foreign currency through the spot route.

“RBI might keep changing the strategy depending upon how much they have intervened in forwards, as these will also become spot some day. RBI will adopt a mix of strategies to mop excess liquidity, including reverse repos and the market stabilisation scheme (MSS).

It might not tweak the cash reserve ratio (CRR),” said Ashutosh Khajuria, executive director, Federal Bank.

CRR is now four per cent of banks' net demand and time liabilities. In the past, they'd asked RBI to reduce this, as CRR balances do not generate interest for banks.

In May, the trend was different, with net purchase of foreign currency from the spot market at $2.58 bn, compared with net forward purchases worth $1.86 bn. In spot market transactions, the settlement happens in two days. So, when dollars are bought from here, the rupee liquidity flows within two days. When the intervention is done through forward contracts, there is no immediate rupee liquidity into the system due to dollar purchases.

“We are reaching a stage where for continuous intervention by RBI, they would require fairly aggressive sterilisation in the bond market... Going forward, RBI will have to choose between maintaining the sanctity of the monetary policy versus the level of intervention they can do. This is going to be probably the key driving factor on how much they are able to intervene in the spot market,” said Neeraj Gambhir, managing director and head of fixed income at Nomura, in a media roundtable last week.

To suck out excess liquidity from the system, RBI had last month announced an open market sale of government bonds, which had surprised the market and yields had shot up. The central bank had announced the sale for a notified amount of Rs 10,000 crore but, ultimately, Rs 8,270 crore was sucked out of the system.

“There is a cost to interventions by RBI but there are plenty of tools available to handle such sterilisation if required, including ad hoc reverse repos. We are suggesting RBI intervene through these or short-term MSS, rather than long-term open market sales or foreign exchange forwards,” said Ananth Narayan, regional head, financial markets at Standard Chartered Bank.

Interventions through forwards have certain disadvantages. According to Anindya Banerjee, currency analyst, Kotak Securities, these unnecessarily inflate the forward premia. As a result, importers and foreign borrowers do not hedge their exposure.
NEUTRALISING

• RBI intervention strategy changes to net dollar purchase from forwards than spot
• RBI may keep changing strategy depending upon how much they have intervened in forwards
• To suck out excess liquidity, last month RBI announced open market operation sale of government bonds
• But, interventions through forwards inflates the forward premia and importers and foreign borrowers do not hedge their exposures