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The Indian rupee has depreciated sharply ever since the Reserve Bank of India (RBI) committed to buy 1 trillion worth of government bonds. While the increase in rupee liquidity invariably puts pressure on the exchange rate, it is not the whole story.

What the forex market is also fretting about is forward premium, especially since the central bank is sitting on a huge pile of long dollar position.

What happens to the rupee in the forward market has a bearing on the spot exchange rate as well, and vice versa.

Satish Kumar/Mint
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Satish Kumar/Mint


The central bank’s net forward market position stood at $47.38 billion as of January and is expected to have increased further in February as well. RBI releases details of its forex operations with a two-month lag and February’s details are unavailable so far.

What the January figure denotes is that the central bank will be buying dollars at various future dates through forward contracts.

In market parlance, the Reserve Bank is long on the dollar. This means that the counter-party, which in this case are the authorized dealers or banks, will need to supply these dollars to the central bank at those future dates.

What is also notable is that the central bank has built this long dollar position over a very short period of three months. The accompanying chart shows that RBI’s forward dollar position jumped by $33.82 billion between October and January.

Another important thing to note is that most of these contracts are between three and 12 months. This means that some of these contracts will start coming up for delivery this month onwards.

What RBI does in terms of its forward dollar position will have an impact on the rupee going ahead. The central bank has the option to either unwind these contracts or take delivery of dollars or it can roll them over by entering into new longer term contracts.

Historically, RBI has rolled over to avoid disruptions in the market.

Abhishek Goenka, founder and chief executive officer at IFA Global Ltd, believes that the central bank would roll them over this time too.

“The RBI has the option to either unwind its positions or roll over the contracts. We feel that in all probability, the regulator may roll over its forward contracts that come up for delivery," he noted.

Either way, the rupee is expected to be under pressure in the coming weeks. If RBI rolls over its forward contracts, forward premia are expected to remain elevated.

That would drive market participants to buy dollars in the spot market to avoid a steep premium. The one-year forward premia on an implied yield basis has surged roughly 100 basis points since October. A steep forward premia curve indicates that the dollar remains at a premium for a longer time.

“The forward premia curve is very distorted because of the RBI’s position. The rupee will come under additional pressure if the RBI does not roll over the contracts," said a forex dealer, requesting anonymity.

If the central bank takes delivery, it would be buying dollars from the market, which will put pressure on the rupee.

With the second wave of covid infections, weak economic outlook and a central bank with a large hand in the market, the rupee has very little incentive to appreciate.

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