According to analysts and traders, the Indian rupee could be pushed to new lows because of a couple of reasons. First off, there appears to be a shortage of cash dollars in the market and this is bound to put the currency under pressure. Secondly, the Reserve Bank of India (RBI) opted for forwarding market intervention, which means that onshore forward premiums of 1-year have reached their lowest levels in more than 10 years and this also adds pressure.
The Rupee Declines
At 0830 GMT, the annualized forward premium for one year had reached 2.91%, even though it had ended Wednesday at a value of 2.82%. The previous session saw it reach 2.80%, which is the lowest it has been seen since November 25th, 2011. Market analysts said that the situation was not a good one, as dollar scarcity was already a problem and the RBI has compounded it with the delivery of forward contracts.
This saw the rupee reach a record low of 78.39 against the US dollar, even though global crude oil prices had recorded a sharp drop. This drove forward premiums down even further. On Thursday, the Indian rupee was trading at a value of 78.34/35.
According to traders, overseas investors are not going to find carry trades very attractive because of the smaller forward premia. Moreover, if these carry trades unwind, it would mean that the spot rupee faces downward pressure that could drive it towards 79 to 80 levels. If the situation remains this grim, then there could be an even greater decline in premia.
The RBI’s Actions
Until the previous year, the Indian central bank had been purchasing forward dollars, as their goal was to ensure that the spot market did not have an infusion of rupee liquidity. It had intervened in the market in order to put a stop to the excessive appreciation that the Indian rupee had been facing. Market analysts said that the problem of dollar shortage could also be because of persistent outflows of FPI when there is a huge trade deficit.
As of 10th June, the foreign exchange reserves in India declined to $596.46 billion, even though a week earlier they had stood at $601.06 billion. Analysts further noted that the dollar funding problem was not just in India, but had also been seen globally. But, the problem is that it has become severe in India due to the intervention of the RBI.
A cash dollar shortage may eventually become self-perpetuating, something that had been seen in the financial crisis of 2008. The spot rupee could come under pressure even more if there is aggressive hedging by importers. Analysts said that the Reserve Bank of India (RBI) needs to reconsider its intervention strategy once more. In order to meet the dollar demand, it should work towards spot reserves’ drawdown, or things could get much worse. The Indian rupee would continue to decline and this will create further issues for the country.