Stories
Why the Rupee's Problem Lies in the Forward Market, Not Trade Balance
- •The rupee recently slipped close to its all-time low at about 96.70 against the dollar, despite massive RBI interventions and capital raising measures.
- •India's balance of payments deficit remains modest, meaning the extra dollar demand is primarily driven by a surge in the hedging and forward market rather than trade imbalance.
- •Importers have doubled their import bills and are hedging far more, forcing banks to cover short positions by buying heavily in the spot market.
- •A self-fulfilling loop has emerged where expected depreciation drives more hedging, which pushes up premiums, spot demand, and weakens the currency further.
- •Recent RBI measures like the Foreign Exchange Risk Reserve aim to make speculative hedging more expensive and curb the forward-market rush.
Key Questions Answered
The pressure stems from the forward hedging market rather than trade balances, as a doubled monthly import bill and aggressive corporate hedging have vastly multiplied forward dollar demand. When importers buy dollars forward, banks cover those positions in the spot market, generating heavy spot weakness and driving up forward premia.
The RBI restricted cancelled hedges from being rebooked, lowered the unverified exposure hedging limit from $100 million to $5 million, and mandated a 20% unremunerated cash reserve called FERR for importer hedges above $2 million. Additionally, state-run oil companies like IOC, HPCL, and BPCL now receive their full daily dollar needs directly from a special RBI window.
A rising forward premium creates an arbitrage when it exceeds the interest-rate gap between India and the US, prompting capital outflows and tightening rupee liquidity. Meanwhile, because exporters expect continued depreciation matching these premia, they hold back on selling dollars forward, creating a lopsided market behavior that widens the dollar gap.
