RBI dials down use of NDFs to fight dollar, balance rupee stability

By Bhaskar Dutta

 

India’s central bank has started to rein in its ballooning non-deliverable forwards book, according to people familiar with the matter, shifting away from one of its key tools to push back against the strong dollar.

 

The Reserve Bank of India has recently let some short dollar positions in the overseas market expire without rolling into new contracts, the people said, asking not to be named discussing private matters. The contracts had maturities of between one and three months, the people said. 

 

The move suggests a more nuanced approach by the RBI, which previously built a net short position of around $60 billion in the NDF market. It also underscores the complicated balancing act facing the central bank: the unwind has put pressure on the rupee in India’s domestic market, as banks settle their side of the forward trades, the people said. 

 

The rupee is trading near an all-time low after falling around 2% against the dollar this year, but it is still one of the best-performing currencies in Asia and has been more stable than its peers, according to Bloomberg-compiled data.

 

The RBI’s decision to unwind some of its NDF positions came before Sanjay Malhotra became its new Governor on Dec. 11, the people said. Currency traders are now watching closely to see if regime change at the central bank leads to a new strategy following years of interventions on both sides of the market.

 

The RBI didn’t respond to emailed requests for comment. 

 

Local impact

 

The central bank has for years intervened in the currency market to contain the volatility of the rupee. That has led to criticism by the International Monetary Fund, which last year reclassified India’s currency regime as a “stabilized arrangement” from a floating system. The RBI called the move subjective and an overreach of the IMF’s central purpose.

 

The RBI’s decision to unwind some of its NDF trades has spilled over to the onshore rupee market, a separate liquidity pool for trading of the currency. 

 

Banks on the other side of the forward contracts had previously offset their long dollar positions overseas by short selling dollars onshore, taking advantage of an arbitrage between the two markets. But as the central bank has let its offshore contracts unwind, some banks have bought dollars in India to close their positions, the people said. 

 

The rush for forward dollar contracts has led to a surge in onshore forward implied yields, which are influenced both by rate expectations and bets on the currency. The one-month yield has climbed 72 basis points this month, putting it on track for the biggest move in either direction in more than a year. The three-month yield has widened 42 basis points. 

 

The RBI has pushed back against dollar longs, using its reserves to buy rupees onshore. But that has squeezed rupee liquidity at a time when many companies are borrowing the currency to settle their tax bills, showing the complicated juggling act the central bank has to perform to tame its currency. The central bank has, in turn, used repo operations to boost rupee liquidity.