The Indian rupee is expected to strengthen at the start of Monday’s trading session after the Reserve Bank of India (RBI) introduced measures to curb dollar demand and limit speculative activity in the foreign exchange market. However, the changes could also trigger fluctuations in forward premiums and increase hedging costs for businesses.
Traders expect the rupee to appreciate by around 1% to 95.60–95.90 per US dollar, compared with its closing level of 96.73 on Friday.
On Saturday, the RBI introduced new restrictions on foreign exchange transactions. These include a ban on rebooking cancelled rupee-linked foreign exchange derivative contracts, a lower threshold for transactions that do not require proof of underlying exposure, and a requirement for banks to maintain a 20% cash reserve against certain foreign exchange contracts.
The measures could make it more expensive for companies to hedge against rupee depreciation. Banks may pass these additional costs on to clients, potentially changing corporate hedging strategies and reducing speculative activity in the forex market.
The RBI has also opened a special window allowing oil marketing companies to purchase dollars directly from the central bank. This is expected to shift their dollar purchases away from the regular foreign exchange market.
Mitul Kotecha, Head of FX and Emerging Markets Macro Strategy for Asia at Barclays, said the RBI had moved from signalling concerns about excessive rupee weakness to directly restricting dollar demand and speculative trading.
He noted that the measures would change where and when dollars are purchased, rather than address the underlying demand arising from oil imports, trade flows and capital outflows. He added that the outlook remained one of an orderly depreciation of the rupee.
Impact on forward premiums
The RBI’s requirement for banks to set aside 20% cash against certain foreign exchange hedges taken by importers could increase the cost of forward contracts and raise the premiums importers pay for hedging.
However, lower demand for forward dollars from importers could push premiums down in the interbank market. Exporters’ hedging activities remain unaffected by the new measures.
Kotecha said the potential decline in importer demand could put downward pressure on forward premiums. However, higher balance-sheet costs, reduced market liquidity and the RBI’s management of its own forward book could push pricing in the opposite direction.
The overall impact will depend on how market participants adjust their hedging strategies and respond to the central bank’s new restrictions.
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