How the RBI is fighting to defend the Indian rupee

One of the big stories in the last week was the relentless fall in the Indian rupee. The reasons are not far to seek. FPIs are selling and that is leading the rupee lower. In addition, the demand for dollars from the oil companies has put more pressure. The rupee has already weakened beyond 79/$ and looks all set to go beyond 80/$. But that is not the point. The real point is that the RBI has been trying to get into the market and support the rupee briefly before letting the rupee fall. But how does the RBI intervene?

The most simple way of intervening is in the rupee dollar spot market. The RBI would sell dollars if there is too much demand for the dollar so that the dollar appreciation can be stemmed. However, the dollar strength comes largely from the hawkish Fed policy, which is likely to continue. But in the last few years, the RBI has adopted a more lateral approach wherein it handles the dollar value in multiple markets at the same time. This makes the rupee dollar management more effective and focussed. Here is how it is done.

Why did the rupee weaken so sharply in the recent past? One reason was the persistent demand for dollars from the banks and the oil companies. Secondly, dollar strength put pressure on the rupee dollar equation. Thirdly, the forward dollar premiums had crashed due to rising open interest in futures. Low forward premium means that currency traders are not interested in that currency at such low levels of forward premia. Amidst all this, the spike in global oil prices has also had an impact on the value of the rupee versus the dollar.

Here is how the RBI intervenes to defend the rupee against the dollar

The RBI operates across various markets to tweak the rates and give signal of the intent of the RBI. 

    a) A common place of intervention is the dollar spot market. Here, the RBI sells spot dollars to reduce the pressure on the rupee. However, this has a downside in that it can deplete the forex reserves quite fast. India’s forex reserves dipped from $647 billion to just about $594 billion in the last few months due to dollar selling by the RBI in Spot Market.

    b) The second arena of intervention by the RBI is the onshore forwards market. Here the RBI typically dips into its long dollar book to offset some of its spot interventions. Typically, the RBI enters into buy/sell swaps to offset some impact of the spot sales on reserves and money market liquidity. This has sent forward premiums to new lows.

    c) The third area where the RBI operates is the non-deliverable forward (NDF) offshore market which his quite robustly active in Singapore and in Dubai. This is an informal market but many businesses also prefer this market due to the liquidity and the ease of transacting. The RBI has been a late entrant into the offshore market. There is already an onshore NDF market in GIFT city in Gujarat. This keeps the rupee grounded with the global trends. 

    d) Finally, RBI also intervenes in the currency futures market. The RBI has been fairly active in the futures market in recent months and this trend has been on since Raghuram Rajan too charge at the helm of RBI. The RBI’s intervention in the futures markets is smart as it does not result in dollar reserve depletion.