Rupee troubles run deeper than crude oil surge, West Asia conflict

Global yields, hedging shifts and capital outflows add to pressure on the currency

There is more to the rupee's weakness than the West Asia conflict and elevated crude oil prices. Rising global borrowing costs, changes in importer and exporter hedging behaviour, and capital outflows have added to the pressure on the domestic currency.

The rupee has appreciated 0.93 per cent in October so far, but has depreciated 0.14 per cent in the current financial year. The recent recovery proved short-lived, with the currency ending an eight-session winning streak on Thursday as rising crude prices amid the war in West Asia renewed pressure. 

The rupee extended its losses on Friday to close at 94.94 per dollar, against 94.83 in the previous session. The currency had risen from 96.73 per dollar on October 9, close to its all-time low of 96.96 touched in May, to an intraday high of 94.33, aided by dollar inflows linked to the Jio Platforms initial public offering (IPO). 

However, the gains came amid active intervention by the Reserve Bank of India (RBI) in the spot and non-deliverable forwards markets. 

The RBI’s foreign exchange reserves fell by $5.01 billion to $721.02 billion in the week ended October 16. State-owned banks were also buying dollars for oil companies on the central bank’s behalf. The RBI has rolled out several measures to ease pressure on the currency. These include a special dollar window, operational from October 12, to meet the daily dollar requirements of Indian Oil Corporation, Bharat Petroleum Corporation and Hindustan Petroleum Corporation through designated banks. The RBI also tightened rules for banks’ foreign exchange derivative positions and opened concessional swap windows linked to foreign currency non-resident (bank) deposits, overseas foreign currency borrowings and external commercial borrowings. 

The central bank also raised the repo rate by 25 basis points (bps) to 5.5 per cent on October 7. 

However, the pressure on the rupee reflects broader shifts in global capital flows and domestic hedging behaviour. Expansionary fiscal policies and an artificial intelligence (AI)-led investment boom in the US have increased competition for capital, pushing up global borrowing costs. 

“The pressure on the rupee is led by elevated global bond yields, surge in crude oil prices and lately focus on AI-related investments,” said Gaura Sen Gupta, chief economist at IDFC FIRST Bank. The pressure is not limited to India, as the rising cost of capital is affecting emerging markets broadly, she said. 

Domestically, expectations of further rupee depreciation have prompted importers to hedge their dollar payables, while exporters have held back from hedging their dollar receipts. This has increased demand for dollars in the market. The RBI’s foreign exchange risk reserve (FERR) framework seeks to address pressures arising from hedging activity. 

Dislocations in the forward market have added to volatility. Abhishek Goenka, founder and chief executive officer (CEO) of IFA Global, said dollar flows linked to the Jio Platforms IPO and associated funding swaps had widened the basis between spot and forward exchange rates. “Investors sell dollars in cash to subscribe to the IPO and book a forward to hedge currency risk,” Goenka said. 

These transactions, alongside the RBI’s sell-buy swaps to absorb surplus rupee liquidity from the banking system, contributed to the widening of the basis. Exporters’ inability to cancel and rebook forward contracts further exacerbated the dislocation. 

“Basis eased considerably on Thursday, that is, spot went up and forwards came off. However, it is still dislocated and there is further room for it to correct,” Goenka said. He said the 94.20-94.40 per dollar range was a technically strong support zone for the currency, potentially prompting spot buying interest, particularly with Brent crude above $110 per barrel. 

The rupee is also facing pressure from India’s external account imbalances. An Axis Bank report said the current account deficit (CAD) was above levels that could be comfortably financed, particularly as higher global interest rates had reduced the amount of the deficit that could be funded through capital flows. 

This has kept India’s basic balance of payments in deficit for several quarters. Elevated forward premiums also point to a reversal of the covered interest parity relationship, reflecting expectations of rupee depreciation and, to some extent, pushing domestic interest rates higher, the report said. 

Financial outflows through overseas direct investment (ODI) have added to the pressure. RBI data showed that annualised ODI by the financial and business services sector in the current financial year so far was well above levels recorded in earlier periods. And, remittances under the Liberalised Remittance Scheme remained broadly steady. 

Axis Bank said measures may need to extend beyond the current account to address capital outflows. 

It also noted that defending the currency through higher interest rates had not proved successful in previous episodes.