RBI’s increasingly nuanced forex market intervention under Raghuram Rajan - NEWS SENTRY


Thursday, 18 August 2016

RBI’s increasingly nuanced forex market intervention under Raghuram Rajan

The central bank’s intervention in the spot market has yielded the RBI a stable currency. Photo: Bloomberg

The Reserve Bank of India’s (RBI) interventions in the forward segment of the foreign exchange market have not just grown in scale and frequency but has also become more nuanced in the last three years under governor Raghuram Rajan.

Between September 2013 and June 2016, the RBI’s net outstanding position in the forwards market, irrespective of whether it was a net sell or buy position, was an average of $10 billion every month, data showed. During the five-year tenure of former governor D. Subbarao, the average net position was close to $3 billion and it was $2.5 billion during Y.V. Reddy’s tenure.

The RBI has not just played at the shorter end of the forward curve. The most vibrant and high turnover contracts in the forward market are those having tenure of between one month and three months. The RBI has increasingly intervened in the longer tenor maturities as well–the one year and even beyond one year.

The predominant reason behind the increase in the RBI’s forward market contracts is the special swap scheme that it introduced for banks in September 2013. Under the scheme, the banks raised dollars through foreign currency non-resident deposits (FCNR) and then swapped these dollars with the RBI.

“The forward interventions are definitely guided by liquidity management. And partly because the RBI had sell obligations through the FCNR swaps,” said Ashish Parthasarthy, head of treasury at HDFC Bank.

While the increase in intervention stemmed from the FCNR scheme, the central bank bought and sold dollars in the forward market beyond the implication of the scheme as well.

The reason for this increase in the central bank’s frequency and scale of visits to the foreign exchange market lies in the RBI’s change in its liquidity stance. Under Rajan, the central bank had adopted the thinking that a liquidity deficit is best for transmission of policy rate changes onto market and loan rates.

In line with the recommendations of the Urjit Patel committee report on monetary policy framework, the RBI had maintained the liquidity deficit around 1% of banks’ deposits.

This stance necessitated a more nuanced approach to intervention and mere buying and selling of dollars in the spot market alone would not give the desired results to the RBI.

Every time the RBI bought dollars, it released an equivalent amount of rupees into the system, thus giving a boost to liquidity.

Even as it increased its hold on the spot currency market through massive purchases of dollars, it soaked up the rupees flushed into banks through its purchases by taking counter position in the forward market.

Its spot market interventions are well known. Between September 2013 and June 2016, the RBI was a net buyer of an aggregate $87 billion. This rivals with the dollar buying spree during Reddy’s period which was characterised by unprecedented inflows. In the first three years of his tenure, Reddy orchestrated a cumulative $54.1 billion worth of dollar buying (September 2003-September 2006). In the next two years, the RBI soaked up $94 billion.

The central bank’s intervention in the spot market has yielded the RBI a stable currency. The volatility of the rupee is now down to the levels seen before the global financial crisis of 2008. However, the central bank’s interventions in the forward market have made hedge costs escalate and thereby driven off companies from hedging their forex exposure. This has been an unsavoury outcome of the RBI’s forward market business.

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