InvestorQ : How exactly does the RBI intervene to defend the Indian rupee?
Aditi Sharma made post

How exactly does the RBI intervene to defend the Indian rupee?

Mahima Roy answered.
1 year ago

Why did the rupee fall so sharply in recent weeks from 74/$ to 78/$? The persistent demand for dollars from the oil companies played a major role. Of course, the risk off investing combined with the Fed hawkishness added to the dollar strength and put pressure on the rupee. An important aspect is that the forward dollar premiums had crashed due to rising open interest in futures. When these premiums crash, the global traders are not really interested in rupee positions. All these factors led to the sharp fall in the rupee.

How does the RBI intervene to defend the rupee. Remember, the RBI defends the rupee from too much weakness and from too much strength. It works both ways. The simplest is in the rupee dollar spot market. RBI sells dollars if there is too much demand for the dollar and buys dollars if there is too much of dollar selling. This is the most common strategy. However, when this stems from a strong dollar, then RBI can be of little help. That is why the RBI now looks at multiple attack points to manage the rupee in a managed float.

Here is how the RBI spans across various currency and forward markets to manage the rupee levels.

· The first is spot market intervention. Here, the RBI sells spot dollars to reduce the pressure on the rupee. However, this can deplete the forex reserves quite fast. In the last few months, we have seen India‘s forex reserves dip from $647 billion to just about $590 billion so the RBI tends to be a lot more vary of this approach and limits it.

· The second area of intervention is through the ready forward market or what is called the onshore forwards market. RBI dips into its long dollar book to offset some of its spot interventions. The central bank enters into buy/sell swaps to offset some impact of the spot sales on reserves. However, the result has been forward premiums at new lows.

· In the last few years, the non-deliverable forwards (NDF) markets for the USDINR has become robust out of Singapore and Dubai. Now that is also possible via the IFSC. This is an informal market but preferred due to the liquidity and the ease of transacting. RBI was a late entrant into the offshore market, but it helps multi-pronged management.

· Since Raghuram Rajan took charge of the RBI, the central bank has intervened in the currency futures market on a routine basis. The RBI’s intervention via the currency futures markets is smart as it does not result in dollar reserve depletion. Also, it is able to do bigger volume in this market.