RBI’s currency intervention ends up hurting rupee carry trade

Its intervention in the spot and forward markets have helped pushed the 12-month implied yields on the rupee to the lowest since 2011

By Subhadip Sircar

The Reserve Bank of India’s currency intervention is making the rupee less attractive for carry traders, analysts said.

Its intervention in the spot and forward markets have helped pushed the 12-month implied yields on the rupee -- typically a reflection of interest rate differentials with the US -- to the lowest since 2011, eroding its appeal.

The sharp decline in the implied yields, known as the dollar-rupee forward premiums, comes about partly due to how the RBI is taking its intervention efforts into the forward markets to ensure rupee liquidity in the banking system. The central bank has spent some $24 billion in the current fiscal year supporting its currency, helping the rupee decline less than Asian peers.

“The important point for us is that we expect the RBI will continue to adopt this strategy to manage liquidity, and we can see a further drop in premiums,” said Amit Pabari, managing director at CR Forex Ltd.

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The RBI’s intervention to support its currency works like this -- it sells dollars in the spot market and buys rupee. On the settlement date, the central bank enters into a second transaction to buy dollars to avoid depleting interbank liquidity of the rupee.

RBI’s Dollar Book

The central bank then sells the greenback again for rupee in the forward markets to maintain the intervention effort, which leads to a compression of returns on India’s currency. The implied yields have dropped to as low as 2.45 per cent on Monday from 4.67 per cent at the start of the year, though that’s partly also due to rates differentials narrowing by 110 basis points as the Federal Reserve hikes quicker than the RBI.

The RBI “has been sterilising its spot dollar sales through buy-sell swaps to avoid sucking liquidity out from the banking system, which is already teetering on the brink of turning into a deficit,” said Abhishek Goenka, chief executive officer at India Forex Advisors Pvt. “Swapping its dollar sales forward also prevents a draw-down of reserves.”

While the strategy limits a draw-down of reserves, it does impact the RBI’s outstanding forward-dollar book. That has plunged to around $20 billion as of August, from this year’s peak levels of about $66 billion in March, according to the central bank’s data.

The rupee fell to a record low of 82.72 to a dollar earlier this month, and is down 9.7 per cent this year. That though compares with declines of around 12 per cent in the Chinese yuan, Malaysian ringgit and Thai baht, while others like the Taiwanese dollar and the South Korean won have seen bigger drops.