Rupee rises against the Dollar after RBI directs banks to cap open rupee positions at $100 million

The Indian rupee gained on Monday, opening at 93.59 to the US dollar, a sharp pullback from its record low of 94.84 touched on Friday after the Reserve Bank of India stepped in directing authorised dealers to ensure that their net open rupee positions in the onshore deliverable market would be maintained within $100 million at the end of each business day. The order would have to be complied with latest by April 10.

The RBI stepped in at a time when oil prices are surging because of the conflict in West Asia, and that has had an adverse impact on the rupee. Banks will now have to unwind their foreign exchange positions above $100 million. The move is expected to trigger a temporary surge in dollar supply and provide immediate relief to the rupee, pointed Devarsh Vakil, head of prime reseatch at HDFC Securities.

Over the past month, the rupee has declined over 4%. Pressure on the rupee has been compounded by the sustained outflow of capital by foreign investors, with over $11 billion withdrawn from Indian equities and bond outflows of $1.6 billion in March, further weakening demand for the currency, according to Jigar Trivedi, senior research analyst at Indusind Securities.

“The measure compels lenders to scale back large positions and curbs their ability to build aggressive one-sided bets against the rupee,” he noted.

Industry analysts say many banks may be holding long US dollar positions well in excess of $100 million and the sale of these large positions to meet the latest directive should strengthen the rupee.

The net open rupee position, essentially, is the unhedged exposure that banks hold overnight. Before Friday’s diktat, the net overnight open position limit for calculating capital charge on forex risk could be fixed by the board of the respective authorised dealers, although that limit could not exceed 25% of their total capital.

Veteran banker Uday Kotak called the situation in West Asia “uncharted territory”, and said that leads to “unconventional policy actions”. “Reminds me of Bimal Jalan play book as RBI Governor in 1998 when the rupee was depreciating sharply after the East Asian crisis. If things get worse geopolitically, is there an opportunity for a new version of FCNR (B) scheme,” he wondered.

Some reports estimate that the total open positions of banks could be as much as $40 billion. Should that be the case, then all banks put together may have to bear mark-to-market losses of as much as Rs 4,000 crore, say analysts.  Not surprisingly, banking stocks were under pressure on Monday, with HDFC Bank, SBI, Axis Bank and Kotak Bank among others declining between 1.5-3.5%.

The RBI typically intervenes in the market by selling dollars when there is a sharp fall in the rupee. It may have “shifted its strategy from direct market intervention to regulatory tightening to preserve its war chest,” felt Vakil of HDFC Securities.