Rupee rises 97 paise to 95.76 against dollar after RBI forex measures

The Indian rupee appreciated 97 paise to open at 95.76 against the US dollar on Monday (October 12), compared with Friday’s (October 9's) close of 96.73, as the market assessed the impact of the Reserve Bank of India’s (RBI) measures to curb dollar demand and speculative activity.

The RBI announced a set of foreign-exchange measures on Saturday, including a ban on rebooking cancelled rupee-linked forex derivative contracts, a lower threshold for transactions that can be undertaken without establishing underlying exposure, and a requirement for banks to set aside 20% cash against certain foreign-exchange contracts.

The central bank has also opened a special window allowing oil marketing companies (OMCs) to buy dollars directly from the RBI rather than in the regular market.

The measures could influence importer demand for forward dollars, increase the cost of currency hedging and affect forward premiums. However, the direction of forward premiums will depend on how the reduction in demand interacts with higher transaction costs and liquidity conditions.

How are the RBI’s measures expected to curb dollar demand?

Importers often buy dollars in the spot market to pay for goods and services purchased overseas. They also use forward contracts to lock in an exchange rate for future payments and protect themselves against a possible depreciation of the rupee.

The RBI’s new rules could make some of these hedging transactions more expensive. Banks will have to set aside 20% cash against certain foreign-exchange contracts, potentially increasing their costs of carrying these positions. Some of the additional costs could be passed on to clients.

The restriction on rebooking cancelled contracts could also limit repeated trading in rupee-linked derivatives. Together, these measures are intended to discourage speculative activity and moderate demand for dollars in the market.

The RBI’s special window for OMCs provides another channel for meeting dollar requirements. By allowing these companies to purchase dollars directly from the central bank, the RBI can divert their demand from the regular foreign-exchange market.

However, the measures do not eliminate the underlying demand for dollars arising from oil imports, trade payments and capital flows. Instead, they change the channels through which some of that demand is met.

Mitul Kotecha, head of FX and emerging markets macro strategy for Asia at Barclays, said the RBI had moved from signalling that the rupee’s weakness might be excessive to directly restraining dollar demand and speculative activity.

The outlook, he said, remained one of an orderly depreciation of the rupee.

Why could the measures affect forward premiums?

Forward premiums represent the difference between the forward exchange rate and the spot exchange rate, generally expressed in annualised terms. They are influenced by interest-rate differentials, demand for forward contracts, currency expectations and market liquidity.

The RBI’s measures could affect premiums in two opposing ways.

Lower importer demand could reduce premiums: If higher hedging costs lead importers to reduce their forward positions, demand for forward dollars could fall. Other things being equal, this could put downward pressure on forward premiums.

Higher hedging costs could push premiums higher: The cash requirement against certain forex contracts could increase banks’ costs, which may be passed on to clients. Tighter liquidity and the RBI’s management of its own forward book could also influence pricing and counter the downward pressure from reduced importer demand.

Exporters’ hedging activity has not been directly affected by the RBI’s measures. Their demand for or supply of forward contracts will therefore remain a factor in determining market pricing.

Kotecha said the combined effect of lower importer demand, higher balance-sheet costs, reduced liquidity and the RBI’s management of its forward book made the direction of forward premiums uncertain.

What does this mean for importers and exporters?

Importers could face higher costs when hedging future dollar payments, depending on how banks pass on the additional costs. Some may reassess their hedging strategies, although their underlying foreign-currency payment obligations remain.

Exporters can continue to use forward contracts to lock in the rupee value of future dollar receipts, as their hedging activity has not been directly affected by the new measures.