RBI's Indian rupee boost to spur rally, trigger swings in forward premiums

MUMBAI: The Indian rupee is poised to rally at Monday’s open after the central bank stepped up efforts to curb dollar demand, while higher costs under ​a new foreign-exchange rule are expected to temper forward dollar buying and impact ‌forward premiums.

The Indian rupee is expected to strengthen about 1% to 95.60-95.90 per dollar, after settling at 96.73 on Friday, traders said.

The Reserve Bank of India on Saturday barred users from rebooking cancelled rupee-linked foreign ​exchange derivative contracts, slashed the threshold for transactions without establishing underlying exposure and ​required banks to set aside 20% cash against certain FX contracts, potentially ⁠raising the cost of hedging against rupee weakness.

The measures are set to alter corporate ​hedging strategies by raising costs of banks for FX forward contracts, which are likely to ​be passed on to clients, while restricting speculative activity in the foreign-exchange market.

This is expected to temper corporate demand for dollars.

In addition to targeting dollar demand from importers, the RBI has opened a special ​window through which oil marketing companies can buy dollars directly from the central bank, diverting ​their purchases from the regular market.

The RBI has moved from signalling that the rupee’s weakness may be ‌excessive ⁠to directly restraining dollar demand and speculative activity in the FX market, Mitul Kotecha, head of FX & EM macro strategy Asia at Barclays, said in a note.

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The measures change where and when dollars are purchased, rather than the underlying demand stemming from oil imports, trade ​flows and capital outflows, ​he said, adding ⁠that the outlook remains for an orderly depreciation of the rupee.

Impact on forward premiums

The RBI’s requirement for banks to set aside 20% ​cash against certain FX hedges taken by importers would make forward ​hedging more expensive ⁠for importers and could push up the premiums they pay.

From the interbank market’s perspective, however, lower demand for forward dollars from importers could pull premiums down. Exporters’ hedging activity, meanwhile, is ⁠not ​affected by the RBI’s measures.

While weaker importer forward demand ​points towards lower premiums, the wider balance-sheet costs, reduced liquidity, and RBI management of its own forward book could ​push pricing in the opposite direction, Kotecha said.