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Informist, Friday, Jun. 6, 2025

 

By Pratiksha

 

MUMBAI – The Reserve Bank of India's bumper liquidity infusion in the form of a 100-basis-point cut in the Cash Reserve Ratio is expected to significantly help the central bank trim its forward book but it will also pull down the Indian rupee, market participants said.

 

Along with a higher-than-expected 50-bps cut in the repo rate to 5.50%, the RBI Friday reduced the CRR by 100 bps to 3% of banks' net demand and time liabilities. The CRR reduction, to be effected in four tranches of 25 bps each, is expected to infuse liquidity to the tune of INR 2.5 trillion into the banking system by December.

 

Market participants said this sustained liquidity support will allow the central bank to trim its forward book at a much quicker pace. "The sharp drop in CRR could help offset the liquidity tightness likely from an unwinding of the RBI's short positions in the FX forward book," Kotak Mahindra Bank said in a report.

 

A large part of the RBI's intervention in the foreign exchange market last year was through buy spot-sell forward swaps. The unwinding of these will mean the RBI has to sell forward dollars, which will drain rupee liquidity. This potential liquidity drain is no longer a concern due to the sharp cut in the CRR.

 

To be sure, the RBI's substantial short forward book has already been declining since March. From a record high of $88.76 billion, the RBI's net outstanding sales of dollar/rupee forward contracts fell to $72.58 billion at the end of April. Of the total, $14.73 billion worth of short forward positions are set to mature in the next three months. The RBI's forward book had ballooned earlier this year as it neutralised its heavy dollar sales in the spot market.

 

While the RBI may trim its forward book, currency market participants expect the central bank to simultaneously purchase dollars in the spot market to either pay for the maturing short positions or to replenish its foreign exchange reserves if these are used for the forward deliveries. This, they said, would exert pressure on the Indian currency. 

 

"The odds of rupee weakening or at least remaining weaker than rest of its peers look more likely to me than not, after today. Because that money has to come from somewhere, right? And inflows are not going to come back soon a big way. I think RBI will have to buy (dollars) from whatever is available in the market," said Dhiraj Nim, FX strategist at ANZ Bank India. "That $14 billion number is lurking, but removing that entirely from spot reserves will not be palatable, so they (RBI) will try to mitigate that." 

 

In fact, while the dollar is as weakening globally, the rupee has been underperforming against its peers, as the central bank sporadically kept buying dollars in the market. If this continues, market participants expect the rupee to depreciate to 86.50-87.00 a dollar in the next three to six months. In May, the rupee was the worst performing currency against Asian units as it fell 1.3% against the greenback.

 

"We think the RBI will be focused on replenishing its FX reserves and is keen to allow the forward book to run off, benefiting from the softer dollar environment at present," Barclays said in a report. "We also continue to believe that the RBI will want to maintain currency competitiveness and would want to avoid any richening of the rupee after the recent decline in the NEER (nominal effective exchange rate)." 

 

RBI Governor Sanjay Malhotra echoed a similar sentiment at the post-policy press conference Friday, saying that the central bank was not "concerned" about the impact of its short forward book on foreign exchange reserves, adding that if there are opportunities, it will build its foreign exchange reserves.

 

India's foreign exchange reserves were $691.5 billion on May 30, down from $692.72 billion from a week earlier. FX reserves had reached a record high of $704 billion at the end of September. These fell to a low of $623.98 billion on Jan. 17 due to the RBI's intervention through sales of dollars.

 

Market participants said the central bank may not want to dent its foreign exchange reserves at a time of increasing and likely prolonged global uncertainty due to US President Donald Trump's unpredictable policies on tariff.

 

Volatile foreign portfolio inflows into India do not help the central bank's case either. So far in 2025, foreign portfolio investors have withdrawn $8.98 billion from the domestic markets on a net basis.

 

"We believe the RBI will continue to accumulate US dollar, with the recent evidence from the April FX forward book and FX reserve developments," Nomura said in a report. "As we highlighted, the April RBI FX forward book showed its net short position fell by $11.77 billion in the month, but spot FX reserves rose by $13.6 billion over the same period (after adjustments, it was $3.1 billion higher)."

 

While there is still scope for the central bank to draw down its huge forward book without hurting the rupee much, the chances for this seem to be few and far between.  End

 

US$1 = INR 85.63

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

 

Edited by Akul Nishant Akhoury

 

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