India’s FX curbs buy rupee some relief but strain bank profits

MUMBAI: The Indian central bank’s surprise cap on forex positions gave the battered rupee a brief reprieve on Monday, but bankers and analysts say the steps will hit banks’ trading revenue and that economic risks will erode currency gains.

The Reserve Bank of India opened a new front in its fight for currency stability on Friday, asking banks to limit net open rupee positions to USD100 million, shifting to an absolute dollar limit from a previous cap of 25 percent of total capital.

The change represents a tightening and comes as the war between Iran and the US and Israel pushes up oil prices and tightens gas supply, heightening economic risks, wild currency swings and worries about capital flight from emerging markets.

India is particularly vulnerable as it imports 90 percent of its oil needs. The higher cost of crude oil imports is expected to widen India’s current account deficit.

Heavy selling from foreign investors pulled the rupee down to a record low of 94.81 against the US dollar on Friday. On Monday, it opened about 1 percent higher at 93.60 before trimming gains.

“This is a move that reflects the RBI’s desire to stabilise the currency in the immediate term while noting that the FX interventions via dollar sales alone may not be cutting it since the risks from the oil price rise are so large,” said Dhiraj Nim, an economist and FX strategist at ANZ.

But the rupee is unlikely to see a lasting recovery, Nim said. “Near-term stability is likely but (the rule change) doesn’t rewrite the fundamental pressures.”

The curbs target the basis trade arbitrage for banks that grew as offshore markets started to price in quicker rupee declines spurred by the Iran war relative to the onshore markets, four bankers said.

Collectively banks had built up arbitrage positions of between USD25 billion and USD35 billion, a person familiar with the central bank’s thinking said. Such positions pressured the spot rupee as banks bought dollars locally and sold offshore, this person explained.

He and all the bankers mentioned in this story requested anonymity as they are not authorised to speak to the media. The RBI did not immediately respond to an email seeking comment.

“By limiting the positions to just onshore positions, the RBI seems to have targeted the popular trade where banks buy USD/INR onshore and sell USD/INR NDF offshore to benefit from the spread,” Michael Wan, senior currency analyst at MUFG Bank, said.