Stories
RBI Rupee Defence Measures Expected to Drain Banking Liquidity and Ease Currency Pressure
- •The Reserve Bank of India has introduced new measures to curb rupee volatility, including a dedicated dollar window for oil marketing companies and stricter rules on foreign exchange derivatives.
- •Analysts from Kotak Mahindra Bank and IDFC FIRST Bank note that these interventions will likely reduce near-term depreciation pressure and soften forward premia.
- •The central bank introduced a Foreign Exchange Risk Reserve requiring authorized dealers to maintain cash reserves with the RBI for certain derivative contracts, raising hedging costs by up to 1.6 percent.
- •The actions are projected to drain significant banking liquidity, with estimates suggesting durable liquidity could drop substantially due to these operations and ongoing RBI interventions.
- •Despite the positive near-term impact on the rupee, external factors like elevated crude oil prices and foreign portfolio outflows could continue to pose medium-term depreciation risks.
Key Questions Answered
The RBI introduced a dedicated dollar window for oil marketing companies through designated banks, barred dealers from allowing users to rebook cancelled rupee-linked foreign exchange derivative contracts, and reduced the threshold for derivative transactions without underlying exposure from USD 100 million to USD 5 million. It also required authorised dealers to maintain a 20 per cent Foreign Exchange Risk Reserve (FERR) in cash for certain derivative contracts exceeding USD 2 million.
The measures are expected to withdraw surplus banking liquidity, with Kotak Mahindra Bank estimating a durable liquidity withdrawal of around Rs 1.5 lakh crore if continued for another month, and IDFC FIRST Bank projecting core liquidity surplus to fall to Rs 2 lakh crore by March 2027. Additionally, the actions are projected to soften forward premia and reduce USD/INR rates in the near term by curbing speculative positions and increasing hedging costs by about 1 to 1.6 per cent.
IDFC FIRST Bank flagged elevated crude oil prices, foreign portfolio outflows, and weak underlying capital flows as key factors that could sustain depreciation pressure despite the new central bank regulations. Additionally, the RBI adjusted its monetary policy stance to calibrated tightening, with analysts expecting the terminal repo rate to settle in the 6 to 6.25 per cent range.
