Forward dollar premia rise as RBI balances liquidity and intervention

MUMBAI: The Indian rupee may be gaining in the spot market but it is losing its premium against the dollar in the forward segment.

To buy dollars one year ahead, market participants would have to pay not less than 4.35% premium on the dollar/rupee rate. This premium was 4.15% a month ago.

What explains this rise especially when surplus rupee liquidity has actually come down?

Analysts attribute this to a possible increased intervention by the Reserve Bank of India (RBI) in the forward market. This is a tested method which the RBI tactically adopts when it wants to curb the rupee’s appreciation but without adding to the rupee liquidity. Whenever the RBI buys dollars, it releases rupee liquidity into the system. This gets postponed when it enters into forward contracts to buy dollars at a future date.

Indeed, data from the RBI shows that the central bank has been intervening in the forward market now and then. The RBI’s net position up to one-year tenure in the forward market was $9.6 billion in July. While this is a fall from the previous month’s level, the drop is because the central bank seems to have run down its dollar position in the up to 1-month bucket. Positions in other tenures have gone up. The trend is likely to have continued in August as well.

Analysts at Kotak Institutional Equities believe that intervention in the forward market could be one of the many tools the central bank would use as it balances multiple objectives. “The RBI has to finely balance its measures to maximize output without giving conflicting signals. Without a single best choice, an optimal mix of tools remains key,” they wrote in a note.

While a greater intervention in the forward market would be a tactical shift, it does not mean the RBI would prefer the rupee to appreciate steadily, analysts said.

Since July, the rupee has appreciated 2.7% and the weekly accretions to the RBI’s forex reserves have been smaller than before. The central bank has slowed down dollar purchased but analysts see this as a temporary phase. “On balance, we expect the RBI to continue with its asymmetrical FX policy of buying FX when the dollar weakens and letting rupee depreciate when it strengthens. As inflation peaks off, we think that there still will be a policy bias towards a weak rupee till growth revives,” analysts at Bank of America research wing wrote in a note dated 16 September.

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