Mumbai: Central bank stepped in to defend its battered currency, which sank to a record low on Thursday, by selling dollars in the market and reducing trading limits for banks.
The two-pronged defense came after the currency hit a series of record lows, with investors and officials piling pressure on the central bank to abandon its hands-off approach to the rupee, which ended off an all-time low hit low earlier in the day.
The rupee has lost more than 18% from a July peak, making it the worst performer in Asia. Weakening economic conditions are expected to keep the rupee under pressure in the near-term, given the central bank’s limited means and appetite to prop up the currency.
The Reserve Bank of India sold dollars, according to traders, sparking what the said was a slew of stop-losses on long dollar positions by market players who had expected the currency, which had plunged to a record low of 54.30 against the dollar, to hit 55 per dollar.
The rupee ended near the day’s highs of 53.64/65 per dollar, marginally stronger than Wednesday’s close but well above the record low plumbed in early deals.
To curb speculative activity in the market resulting from booking and canceling forward contracts, the central bank after market hours reduced the net overnight open position limit or trading limits for banks in the foreign exchange market.
“It is a rare market development,” said Naveen Raghuvanshi, associate vice president for currency trading at Development Credit Bank. “The message RBI is trying to give is that speculative tendencies have to be curbed and genuine demand-supply should be allowed to move the currency rate.”
While the central bank does not set a rupee a target, it does step in to smooth currency market volatility and has been doing so in recent months.
The central bank usually intervenes via state-run banks and its intervention came as a surprise to market participants, particularly exporters, who have become accustomed to its largely passive approach to the currency in recent months.
“Nationalised banks likely triggered the stop losses by selling dollars around the levels of 54.10/15, following which the market momentum took care of the rest for the rupee,” said Hari Chandramgathan, a forex dealer with Federal Bank in Mumbai.
One trader at a large textile exporter said the effect of stop losses being triggered was “sharp.”
That encouraged software and diamond exporters, who had held back their dollar receivables anticipating further decline, to hedge their flows.
Ashtosh Raina, head of forex trading at HDFC Bank said the impact of lowering the trading limits will be “huge because banks will not be able to keep speculative positions open for a long time.”
Apart from reducing banks’ FX trading limits, the RBI also said forward contracts booked by foreign institutional investors, once cancelled, cannot be rebooked.
Traders said one other step the central bank could announce at its monetary policy review on Friday to help shore up the currency would be to boost dollar inflows by removing caps on interest rates on non-resident deposits.
On 23 November, it raised the interest rate ceiling on the non-resident external (NRE) rupee deposits and the foreign currency non-resident banks (FCNRB) deposits.
However, any comfort for the rupee is still some time away given India’s worsening economic growth outlook and a widening trade gap.
“It (the rupee) doesn’t seem to have a circuit breaker and global environment for risk assets is likely to remain poor near term,” said Sean Callow, senior currency strategist at Westpac Banking Corp in Sydney.
Offshore non-deliverable forwards (NDFs) were indicating further weakness, with the one-month rupee NDFs at around 54.18.
Callow said the rupee could test 55 against the dollar in the short term.
However, the central bank’s policy review on Friday could offer some succour to the panicky foreign exchange market.
While markets do not expect an interest rate cut, analysts expect the central bank to signal a stronger resolve to intervene to hold up the beleaguered currency.
“We cannot rule out one more hike if the rupee extends its free-fall beyond 56 (to the dollar),” said J. Moses Harding, head of asset-liabilities committee at IndusInd Bank.