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Given that inflation has mostly been under control in the past few months, the Reserve Bank of India (RBI) is now seen intervening more in the currency market's spot segment than in 2014.
The central bank had been more active in the forward segment in 2014, with inflation remaining high during the first half of the year - any liquidity infusion through intervention in the spot market would have led to further price increase.
The changed strategy has helped RBI maintain liquidity in the system at a comfortable level, at a time when a squeeze in spending by the government for meeting its fiscal deficit target is keeping things tight.
According to treasury officials at state-run banks, the amount of dollar purchases from the forward market continues to be high but the spot-forward ratio has seen a change in recent months. "Currently, the ratio of RBI's dollar flow mop-up through spot and forward segments stands at 40:60. This was 20:80 until recently," said the head of treasury at a large public-sector bank.
RBI has bought dollars whenever there has been an inflow, to maintain exchange-rate stability. The move has, in the process, helped it add to the foreign exchange reserves.
Spot market transactions are settled in two days. That means, rupee liquidity flows into the system within two days of dollars being purchased from the spot market. By comparison, when an intervention is made through forward contracts, no rupee liquidity immediately flows into the system on account of dollar purchases.
According to RBI data (till November 2014), the central bank bought $25.7 billion from the spot market, on a net basis, in the first eleven months of 2014. Outstanding net forward purchases at the end of November stood at $13.24 billion, while net dollar purchase from the spot market in the month was $3.08 billion.
"Earlier, when they wanted to drain liquidity, they would intervene in the forward market. They are not intervening in the forward market (so much) because they want the liquidity to soften a bit. This is just another way of injecting liquidity," said Vijayan Subramani, DBS Bank's managing director (treasury & markets) for India.
The boost in foreign exchange reserves through RBI's mopping of dollars is aimed at tackling external shocks. Data show that the reserves rose from a 39-month low of $274 billion on September 6, 2013, to an all-time high of $322.14 billion in the week ended January 16 this year. In the current financial year, RBI has added a little more than $18 billion to the reserves, which currently stand at $322.04 billion.
"One reason is to keep liquidity comfortable in the March quarter (of this financial year). RBI is also keeping in mind the credit pick that might happen in this quarter. It can afford to follow this strategy, as inflation is under control," said Ashutosh Khajuria, president (treasury), Federal Bank.
The rate of India's retail inflation rose to five per cent on an annual basis in December, compared with November's 4.38 per cent, which was the slowest pace since January 2012. The numbers were below RBI's central forecast of six per cent for retail inflation by March 2015.
That the central bank was comfortable with the inflation level was evident in its decision to effect an out-of-turn cut of 25 basis points in the repo rate - at which it lends to commercial banks - on January 15.
