RBI’s aggressive buying of long contracts in forward market suggests pressure ahead for Rupee

The RBI’s latest monthly bulletin shows that the central bank is intervening aggressively in the forward market for rupee. Net outstanding long positions in rupee forwards, towards the end of January 2021, was $47.3 billion, the highest since 2014.

The central bank’s higher intervention in the forward market has to be seen in conjunction with its reduced activity in the rupee spot market, continued FPI inflows into equity market and the need to facilitate the large borrowing programme of the Centre.

Change in stance

The central bank held net short positions in rupee forwards between September 2018 and July 2020. But it started increasing its long positions from August 2020 onwards; net outstanding long positions spiked to $10.3 billion in August 2020. This position has gradually increased to $47.3 billion by January 2021.

Besides going long in the forward market, the RBI has also built positions in the exchange traded rupee derivatives. It was long in rupee futures worth $2.19 billion as on January 31, 2021.

Why the accumulation?

The purchase of long contracts in forwards indicate the central bank’s view that the rupee could come under pressure going forward. While it can sell dollars in the spot market and thus support the rupee, such interventions result in depleting the forex reserves and sucking liquidity out of the system.

The RBI continued to buy dollars in the spot market through FY21 in a bid to bolster its reserves as well as to prevent sharp appreciation in the rupee. This activity has, however, resulted in increasing the liquidity in the system. RBI’s net purchases of dollars in the spot market amounts to $76.3 billion from May 2020 to January 2021.

But going by the data on accretion to forex reserves, it is seen that the central bank halted its dollar purchases since February, possibly on account of the need to support the Centre’s gigantic borrowing programme going forward and to better manage the liquidity in the system.

Also, the central bank’s accumulation of forwards was resulting in hiking the forward premium, especially in the 3-month forward contracts.

What do RBI’s actions imply?

If we break down the forward contracts outstanding towards the end of January, it is seen that the RBI held net long positions amounting to $44 billion in the 3 month to 1-year contracts. In the contracts with less than 3-month maturity it had $10 billion worth of net long positions and in contracts maturing beyond 1 year, it held net short position of $7.9 billion.

This seems to imply that the central bank expects the rupee to weaken in the 3-month to 1-year period. The long contracts held in this period can be sold to help the rupee appreciate, without affecting the liquidity in the system.

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