Rupee Slips After 3-Day Rally On Dollar Demand.

After an upward trend that lasted three days, the value of the Indian rupee, as measured against the US dollar, ended down 0.43% at 89.65 on Monday due to continued foreign exchange volatility and increased demand for the dollar.

The Reserve Bank of India (RBI) has been actively supporting the currency through intervention in the foreign exchange market, selling a net $11.88 billion in October to support the rupee.

This is evidenced by its monthly report, which shows that the central bank intervened frequently as the Indian rupee weakened to around 88.80 in October. Last week, the rupee traded as low as 91.08 before recovering due to the central bank's actions.

But the question remains, what ongoing problems does the rupee face, and how successful will the RBI be in using these types of support?

How Did RBI's October Interventions Unfold?

The RBI's forex market action in October was highly significant, given the amount it bought ($17.68 billion) compared to what it sold ($29.56 billion), resulting in a large net outflow that helped stabilise the rupee price, which finished at 88.7650 by the end of October.

This was a significantly larger intervention than the $7.91 billion in net spot sell-offs in September, due to increased volatility resulting from global capital flows and events. The RBI uses its forex market intervention tools to limit the volatility of the forex market (spot and forward) to optimise market orderliness.

RBI interventions protect the foreign reserves, while simultaneously signalling the RBI’s continued commitment to meeting its long-term inflation target, without targeting fixed exchange rates. The October transactions by the RBI demonstrated the institution's preparedness to intervene when necessary in response to external pressures on the currency value.

The amount of outstanding net short dollar position in the rupee forward market increased from $59.41 billion to $63.61 billion, providing the RBI with additional funding to help protect the Indian currency against depreciation.

Dollar Demand Pressures Post-Rally

The markets started repurchasing dollars immediately following the recent appreciation of the rupee; however, demand for the rupee has been lower than that for the dollar, putting the rupee under pressure to drop back toward its recent lows, despite supported intervention by the RBI.

As uncertain import and investment activities continue to create demand for the dollar, the upward movement of the rupee over the last three days was followed by a downward movement, as the fundamentals of the currency markets once again took over. Therefore, it is crucial to understand how sensitive the rupee is to changes in the flows of foreign investments in and out of India.

By taking a multi-pronged approach to forex interventions, consisting of spot sales, forward sales, and liquidity operations, the RBI is attempting to smooth the volatility of both the dollar and rupee foreign exchange markets without aggressively depleting its foreign exchange reserves. The RBI’s intervention following the rupee’s move to the 91.075 level underscores its proactive intent to stabilise the currency and curb excessive volatility.

Forward Market Buffers And Outlook

An increased forward sales position with the RBI allows for effective management of future pressures through the rolling of positions as required. It also provides a buffer or shock absorber for calibrated spot interventions. The direction of the rupee is dependent on Foreign Portfolio Investment (FPI) flows, oil prices, and US policy changes.

The continued defence of the rupee protects trade competitiveness while at the same time shielding against an inflation pass-through from imports. As the dollar continues to strengthen, the RBI continues to provide growth support while maintaining stabilisation.

As the rupee continues to weaken against the dollar, and with the RBI reporting net sales of $11.88 billion, the key question for markets is how long forward interventions and foreign exchange reserves can continue to provide an effective defence against persistent depreciation pressures.

Sources:

Economic Times
Business Standard
Money Control
Market Screener