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India’s central bank has ramped up its trading of non-deliverable forwards, turning the offshore market into its main tool to push back against a strong dollar.
The Reserve Bank of India has built up a roughly $60 billion book of net short dollar positions in the overseas NDF market, according to traders. That dwarfs the official record of $19 billion net shorts across both onshore and offshore markets, which was set in August.
The trades represent a stark shift in approach by the central bank, which has previously focused more on taming volatility in its domestic market. The RBI’s recent blitz of NDF trading means the bulk of its currency intervention is now happening overseas. The central bank’s net short dollar position across both markets is around $70 billion, according to research by Barclays Plc.
“The NDF market has grown very large so the RBI has to intervene to signal to the offshore market its forex policy intention,” said Claudio Piron, co-head of Asia Pacific rates and FX strategy at BofA Securities. “The offshore market is often driving the onshore market, a case of the tail wagging the dog, which policymakers never liked.”
The monetary authority has been primarily intervening in the one-month to three month tenors via the Bank for International Settlements, the traders said, adding that the RBI prefers to intervene before the local market opens.
An email sent to the RBI was unanswered. BIS does not acknowledge or discuss banking relationships as a policy, a spokesperson said in an emailed response to questions.
The interventions could become a headache for the central bank in the future, forcing it to navigate the tricky unwind of positions that will eventually need to be settled. But so far, they appear to have done their job: The rupee fared much better than other emerging market currencies following the US election on Nov. 5, which left traders scrambling to buy dollars on expectations of higher tariffs.
The RBI has previously intervened in the opposite direction, pushing back against rupee appreciation with a series of dollar purchases that swelled India’s foreign exchange reserves to a record of more $700 billion in late September, although the stockpile has since declined. The rupee traded at around 84.50 per dollar on Friday, hovering just above its all-time low.
Read: RBI Sheds Rare Light on Interventions With Use of Derivatives
Pressure Building
Intervention in the offshore markets has clear advantages for the central bank, said Dhiraj Nim, a currency strategist at Australia and New Zealand Banking Group Ltd. in Mumbai. It signals to the spot market about the RBI’s intent, encourages discipline among speculators and doesn’t burn through the central bank’s official spot reserves, a closely watched benchmark of how much firepower the RBI has to respond in times of stress, he said.
But the offshore interventions are a double-edged sword. Although the NDF trades have helped tame rupee volatility, they are building up pressure for the future, since the central bank will eventually have to close the forward contracts by buying dollars.
“Unlike in the past months, the RBI may find itself having to buy dollars at higher USD/INR rates, which would add to its intervention burden,” Barclays strategists including Mitul Kotecha wrote in a note.
The RBI’s activity in the offshore market is a sea change from little over a decade ago, when it refused to recognize the existence of any rupee trading outside India. Since then, India’s rising global importance has resulted in an exponential growth in offshore rupee trading, with rupee volumes in London now bigger than those in Mumbai, according to the BIS.
Late last year, the International Monetary Fund reclassified India’s currency regime as a “stabilized arrangement” from a floating system, pointing to what it called “excessive” interventions in the currency market. The RBI called the decision “subjective” and an “overreach” of the IMF’s central purpose.
India has also been intervening in the spot market using its official reserves, its more typical approach to defending the rupee. The country’s foreign exchange reserves fell to about $658 billion as of Nov. 15, according to RBI data.
The NDF market for dollar-rupee trades reached a daily average of around $46.4 billion in 2022, according to the latest Triennial survey from the BIS, almost three times its size in 2016.
--With assistance from Marcus Wong.
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