RBI acts in forwards market to protect forex reserves, pulls down premiums

This move by the central bank results in premiums crashing

The Reserve Bank of India’s (RBI’s) recent decision to take advance delivery of outstanding long-forward dollar positions points to its desire to protect the fast-depleting foreign exchange (forex) reserves, analysts said. The RBI’s actions have triggered a sharp decline in dollar/rupee forward premiums.

Currency analysts who spoke to Business Standard said at a time when significant dollar strength has been pushing the rupee to record lows, the RBI may be wishing to ensure that its forex reserves do not drop below a certain level.

“I think because we saw a precipitous headline fall in the reserves from $640 billion to $600 billion, all of it may not be because of outright sales,” said Ananth Narayan, associate professor at SP Jain Institute of Management and Research.

IFA Global’s chief executive officer (CEO) Abhishek Goenka said it was possible that the central bank does not want the headline reserves to fall much below $600 billion.

Latest RBI data showed that forex reserves dropped by over $10 billion to $590.59 billion in just two weeks. The fall was $5.9 billion in the week ended June 17 and $4.6 billion in the week ended June 10.

The current level of forex reserves is enough for less than 10 months of imports projected for 2022-23.

“I guess they don’t want to show a large reduction in the reserves because of which they prefer to sell from the forward market. We also know they have a lot of outstanding forward purchases. So, they are simply in a way, negating that,” said Narayan, who has served on several RBI committees in the past.

On Wednesday, one-year annualised dollar/rupee premiums plunged to their lowest level since November 2011, falling below 3 per cent.

Slump in the forward premium occurred because of the RBI’s decision to take advance delivery of some of its outstanding long-forward dollar positions, foreign exchange dealers said.

In the past week, the central bank has been said to have conducted buy-sell swaps in the foreign exchange market.

Under these transactions, it has been buying dollars for now and then selling them for delivery next month, October and November, dealers said.

Through spot market interventions, the RBI has been fiercely protecting the rupee from excessive volatility in the face of aggressive US rate hikes and elevated commodity prices.

While the rupee, earlier this week, touched a record low of 78.39/$, the 4.9 per cent year-to-date depreciation in the domestic currency versus the dollar is less than the weakness suffered by many emerging market currencies.

In this backdrop, it is likely that the RBI has been looking to stem the reduction in its headline reserves. It is taking delivery of its outstanding forwards book, which as of April, was close to $64 billion, the latest RBI Bulletin showed.

In a report for the Observatory Group dated June 23, Narayan wrote that the outstanding RBI net forward purchases may have fallen to around $50 billion now. The RBI’s likely activities are reflected in the forward premium curve.

The one-year forward premium has recovered from its 11-year low, settling at 3.15 per cent on Friday. However, the rate is still sharply lower than 3.76 per cent at the beginning of the month, Bloomberg data showed.

On December 31, the rate was at 4.65 per cent. It then dropped to 3.81 per cent at the end of March.

“If they are intervening in the forwards, it does not lead to a deflation of forex reserves.

At the same time, the RBI has been holding these large amounts of long positions in the forwards market for a long time now,” Anindya Banerjee, vice-president, currency derivatives & interest rate derivatives at Kotak Securities, said.

He added, “By nature, these contracts expire. At the same time, they have a maintenance cost. So, the RBI is basically trying to balance all these needs.”

Analysts, however, warned that the risk associated with the sharp decline in forward premium rates was that of importers rushing to lock in dollar purchases. This could compel the RBI to expend more of its reserves. The forward premium rate represents the hedging cost for importers.