The Reserve Bank of India’s (RBI) weekend measures to support the rupee and manage liquidity have triggered a near-term tactical rally, but the currency could weaken past 96 against the dollar by the end of the year, according to Mitul Kotecha, Head of FX and EM Macro Strategy-Asia at Barclays.
The central bank introduced a series of steps to curb speculative dollar demand. Banks must now set aside 20% of the rupee equivalent for specified forex derivative contracts exceeding $2 million as a cash reserve. The RBI also tightened restrictions on cancelling and rebooking rupee-linked forex contracts and slashed the threshold for unbacked forex derivative positions to $5 million from $100 million. Additionally, the daily dollar requirements of three public sector oil marketing companies (OMC) will be met through designated banks rather than the open market.
While the interventions sparked an approximate 1% appreciation in the currency, the underlying macroeconomic pressures remain intact. “I think, look, short term, this is a tactical move for the rupee,” Kotecha noted. “It strengthens it near term. It takes out some of that speculative element.” However, external factors such as elevated crude prices, a pressured trade deficit, and weak foreign portfolio investment flows persist. Barclays projects Brent crude will end the year at $115 per barrel. Consequently, the rupee is expected to resume a gradual depreciation, potentially breaching the 96 or 97 levels before the year concludes.
Addressing concerns about the central bank’s dollar supply to oil marketing companies, Madan Sabnavis, Chief Economist, Bank of Baroda (BoB), clarified that the transactions will be bilateral deals with banks. “It’s not that the RBIs reserves of maybe what we have here around $600 plus billion in forex currency is going to be used to fund the requirements of the OMCs,” he explained. The forex reserves will not be impacted by the move.
On the liquidity front, the RBI raised the daily minimum cash reserve requirement for banks from 90% to 99% for the fortnight ending October 31, although the overall cash reserve ratio remains unchanged at 3%. This follows open market operation (OMO) sales of approximately ₹1 lakh crore in September and an announced ₹25,000 crore sale for October 13, aimed at draining excess liquidity hovering around ₹4 lakh crore.
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Rupee could weaken past 96 by year-end despite RBI measures, forecasts Barclays’ Mitul Kotecha
The tighter daily balance restricts banks from deploying funds into reverse repo operations to earn interest. Previously, maintaining a 90% daily balance on the 3% cash reserve ratio effectively lowered the requirement to 2.7%, allowing banks to park that additional 9% margin in variable rate reverse repo facilities to earn around 5.49%. The central bank’s objective is to eliminate this leeway and align the overnight call money rate closer to the repo rate. Viewing the hike as a temporary adjustment, Sabnavis expects a swift reversal. “In my view, I think it’s a short-term measure,” he observed, noting that the RBI will carefully monitor how system surpluses evolve.
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