The seal of the Reserve Bank of India hangs on a wall at the headquarters in Mumbai. (Photographer: Scott Eells/Bloomberg)

RBI Targets Rupee Forwards as Cash Hinders Spot Intervention

(Bloomberg) -- India’s central bank is increasingly turning to the forwards market for currency intervention, as a banking system already flooded with cash limits its ability to act in the spot market.

The Reserve Bank of India bought $8 billion of foreign currency in the forwards market in March, latest official data released this month showed, as the rupee capped its best first-quarter performance in four decades. The purchase was the highest in almost three years, according to calculations by Bloomberg News. FirstRand Ltd. and Standard Chartered Plc say the authority will continue to prefer this method over spot intervention.

RBI Targets Rupee Forwards as Cash Hinders Spot Intervention

The reason? Buying dollars from the spot market adds rupee liquidity to the banking system. That’s something RBI Governor Urjit Patel wants to avoid as Prime Minister Narendra Modi’s November recall of high-value currency notes has already flooded lenders with surplus funds that risk stoking inflation and jeopardizing monetary policy.

“Till the domestic liquidity situation normalizes, you could expect higher-than-normal intervention in the forwards market,” said Divya Devesh, a Singapore-based Asia FX strategist at Standard Chartered, which is the rupee’s most accurate forecaster based on Bloomberg’s quarterly rankings.

When intervening in the forwards market, the RBI typically enters into sell-buy swaps with banks, whereby it purchases dollars in the spot market and subsequently sells them. It then buys dollars in the forwards market to push back the liquidity injection to a future date.

The rupee has climbed 5.9 percent against the dollar this year. The currency’s strength is adversely hitting Indian exports, Arvind Subramanian, chief economic adviser to the finance ministry, said last month, adding that the nation needs to ensure exchange rates remain competitive.

The Indian currency fell 0.1 percent to 64.1575 per dollar in Mumbai on Wednesday, after traders said state-run lenders were seen buying dollars on behalf of the central bank.

The RBI intervenes only to mitigate volatility and the exchange rate is broadly market-determined, Governor Patel reiterated last month. The rupee’s gains have come as the central bank has stepped up its rhetoric on inflation, with investors seeing the authority as turning increasingly hawkish.

The forwards intervention strategy will cause importers’ hedging to fall, while exporters will be incentivised to hedge more, according to Gopikrishnan MS, Devesh’s colleague in Mumbai.

“RBI’s intervention through the forwards market will keep foreign-exchange swap rates at elevated levels,” said Gopikrishnan, head of foreign exchange, rates and credit for South Asia at Standard Chartered.

March’s forward-market purchases of $8 billion compared with just $2.3 billion for February. The RBI also bought $3.5 billion in the spot market in March, the highest in six months, and compared with $1.2 billion in February.

“The intervention is going to be more through forwards,” said Anindya Banerjee, associate vice president for currency derivatives at Kotak Securities Ltd. in Mumbai. “What they are aiming to achieve is to curb rupee gains without adding to the high liquidity surplus.’’