India forces banks to unwind rupee bets as Iran war drives currency to record lows

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MUMBAI – India’s most dramatic step in more than a decade to curb speculation in the foreign-exchange market delivered fleeting gains, with an initial jump in the rupee rapidly fading, reflecting the deep challenges the central bank faces in supporting Asia’s worst-performing currency.

After surging as much as 1.4 per cent when trading opened on March 30, the rupee quickly pared gains to just 0.3 per cent.

The Reserve Bank of India (RBI) on March 27 said it will cap the open positions lenders can hold in the onshore currency market at US$100 million (S$129 million) per day, forcing them to shrink their books.

The change, effective April 10, limits their ability to run large one-sided bets against the rupee.

The intervention underscores the RBI’s shrinking flexibility, as foreign-exchange reserves have shrunk in the first three weeks of March amid efforts to defend the rupee following the Iran conflict.

The measure immediately drew pushback, with banks warning that unwinding positions totalling at least US$30 billion could lead to steep losses. They have requested the rule apply to only new bets, people familiar with the matter said earlier.

“Banks are running massive arbitrage positions, wherein they are short in the offshore market and long dollar onshore,” said Mr Abhishek Goenka, founder of IFA Global.

Since the RBI’s limit applies only to onshore positions, banks are forced to trim those wagers, which require them to sell dollars locally, he said.

Still, the RBI move is unlikely to alter the broader outlook, given the still-elevated oil prices. The rupee has already given back much of March 30’s gain due to demand for the greenback from oil importers at lower levels, according to Mr Anil Kumar Bhansali, head of treasury at Finrex Treasury Advisors.

Part of the challenge for policymakers is where that pressure is coming from. While the rupee trades in Mumbai, price signals are increasingly determined overseas in hubs like Singapore, London and New York through derivatives that let investors take positions without access to domestic markets.

India has been among the hardest hit by the Iran war and rising commodity costs, given its heavy reliance on energy imports.

The rupee has fallen more than 4 per cent since the conflict began on Feb 28, to 94.82 per US dollar as at March 27. Uncertainty over the duration of the conflict has prompted global funds to pull about US$12 billion from local shares, while index-eligible bonds have seen record outflows of US$1.6 billion in March.

Brent prices are holding well above US$110 per barrel, far higher than the US$70 baseline assumed by the RBI in October. Bloomberg Economics estimates that crude at US$100 a barrel and gas prices 50 per cent above pre-war levels will raise India’s import bill by US$5 billion a month.

The RBI’s move may help the rupee in the near term “but history shows such actions have limited impact”, Systematix Institutional Equities analyst Siddharth Rajpurohit said in a note. “Pressure will likely continue if crude prices remain around US$100,” he added, and warned that the brokerage’s target of 100 to a dollar “may occur sooner than later”. BLOOMBERG