India unveils tough curbs on dollar demand to defend rupee

MUMBAI: India on Saturday unveiled fresh measures to shore up the rupee, redirecting oil companies’ dollar purchases away from the spot market and tightening hedging rules as the currency hovers near record lows.

The steps by the Reserve Bank of India come as persistent pressure on the rupee, fuelled by surging oil prices and global bond yields, has driven the currency down more than 7% this year.

The central bank will open a special window to meet the daily dollar requirements of three state-run oil-marketing companies, easing pressure on the spot market.

Under such an arrangement, used during periods of currency stress, the RBI provides oil companies dollars directly from its foreign exchange reserves. Indian Oil, Hindustan Petroleum and Bharat Petroleum will be allowed to access the facility from Monday, the RBI said.

“Addressing oil companies’ dollar requirements removes one of the largest sources of demand from the FX market, which should help reduce volatility but it will show up in a depletion of reserves,” said Dhiraj Nim, FX strategist at ANZ Bank in Mumbai.

After the steps were announced, the rupee strengthened by about 0.6% against the dollar in the non-deliverable forward market, albeit in thin trading.

Elevated demand for protection against further rupee losses has weighed on the currency in recent months, with importers’ appetite for dollars far exceeding exporter supply.

The central bank has responded by tightening rules on speculative corporate activity and raising the cost of protection against further rupee weakness.

The RBI is “trying to moderate potentially destabilising derivative demand, improve the integrity of underlying exposure verification and discourage circumvention through multiple transactions or repeated rebooking,” a person familiar with the central bank’s thinking said, commenting on condition of anonymity as they are not authorized to speak to the media.

The central bank has mandated that forex dealers maintain a 20% “foreign exchange risk reserve” on derivative contracts used to buy foreign currency against the rupee, for the purposes of hedging current account transactions. The requirement applies to transactions with a notional value exceeding $2 million.

The reserve requirement will lift the cost of buying protection against further rupee weakness, helping to discourage excessive hedging, two bankers said, speaking on the condition of anonymity.

Chinese authorities have previously used similar tools to discourage one-way bets against the yuan.

India’s central bank has also slashed the limits on the size of derivative transactions users can undertake without proof of underlying exposure to $5 million from $100 million. The lower cap applies across all derivative products, including exchange-traded futures.

The measures follow more than $140 billion in capital inflows raised through one-off policy steps to encourage overseas FX deposits alongside offshore borrowing by state-run firms and banks.

Yet despite those inflows, sustained central bank intervention and a rate hike earlier this week, the rupee remains under pressure.

The steps should temper, but not eliminate, pressure on the rupee, ANZ’s Nim said. “The underlying drivers, including oil prices and capital flows, remain, and the real test will be how reserves and the rupee behave in the coming week,” Nim added.