Despite the Reserve Bank of India's recent cap on banks' forex positions, the rupee's initial gains quickly faded, highlighting persistent underlying pressures from rising crude oil prices, geopolitical tensions, and a strong dollar environment.
Key Points
- The RBI's cap on banks' net open forex positions, intended to support the rupee, provided only a fleeting boost, with the currency quickly reversing its initial gains.
- Market participants suggest the directive may have had unintended consequences, failing to address the fundamental pressures on the rupee.
- Rising crude oil prices, persistent geopolitical tensions, and a strong dollar environment are key factors contributing to the rupee's vulnerability.
- India's balance-of-payments position is at risk of further deterioration, with increasing pressures on the capital and financial account.
- The move to rationalise banks' open positions appears to have widened the gap between onshore and offshore markets, leading to emerging liquidity strains.
The Reserve Bank of India's (RBI's) cap on the forex positions of banks has done little to ease the underlying pressure on the rupee with the initial boost from the move quickly fading.
Market participants said the directive on net open positions might have had unintended consequences.
The rupee, after opening over 1 per cent stronger on Monday, reversed course to breach the 95-per-dollar mark with multiple pressures continuing to weigh on the currency.
RBI's Intervention and Market Reaction
On Friday, the RBI capped banks' net open position (NOP) in the onshore forex market to $100 million, overriding the board-set internal cap of 25 per cent of capital.
After building up its forward books, onshore and offshore, estimated to hit around $100 billion by March, and selling over $15 billion from reserves in the first three weeks of March, the RBI has turned to additional measures to support the rupee.
Market participants said that while this move sharply restricted banks' ability to hold long-dollar positions in the onshore market, it was unlikely to address the underlying pressures on the rupee.
Underlying Dynamics and Vulnerabilities
"The bottom line is that the RBI's cap does not change the underlying dynamics that fuelled pressure on the currency in the first place," a report by Barclays said.
"We note that while the RBI cap had a knee-jerk impact, initially boosting the INR, the effect is already fading quickly.
"In short, the rupee remains particularly vulnerable to an oil supply shock, while India's BoP position may deteriorate further, and capital and financial account pressures are increasing," the report said, adding importers' dollar buying was also expected to pick up, likely outweighing any exporter dollar selling.
Impact of Global Factors
The RBI's outstanding exposure on forward books adds to pressure on dollar buying.
The rupee remains particularly vulnerable to the oil shock, with Brent crude oil price trading at $115 per barrel, along with India's balance-of-payments position at risk of further deterioration amid rising pressures on the capital and financial account.
"Despite initial strength supported by the RBI's move to reduce banks' overnight net open position limits, the rupee failed to hold gains and reversed sharply due to a combination of rising crude oil prices, persistent geopolitical tensions, and a strong dollar environment," said Abhishek Goenka, founder and chief executive officer, IFA Global.
Onshore vs. Offshore Market Discrepancy
The State Bank of India said in a report that the move to rationalise banks' open positions, while well intentioned, appeared to have widened the gap between onshore and offshore markets.
Typically, Indian banks, public and private, run long positions in the onshore market and short positions offshore, while foreign banks tend to do the opposite.
As these positions are unwinding, liquidity strains are beginning to emerge, potentially creating a feedback loop that pushes offshore premiums sharply higher.
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