Rupee’s rally on lower oil prices is likely to be constrained by the central
bank’s unwinding of its sizable FX forward book and hedging of
interest obligations on foreign currency deposits raised by
Indian banks.
The Reserve Bank of India’s short-dollar forward book is
estimated to have ballooned to an all-time high of nearly $110
billion, according to two officials at foreign banks, up from
$96 billion in April.
The surge follows persistent central bank intervention
across both domestic forwards and non-deliverable forward
markets to support the rupee.
The forward book is poised to expand further, with banks
passing on the currency risk from foreign-currency inflows
raised by them to the RBI via swaps. State-run enterprises and
lenders are expected to add to this buildup through dollar-rupee
swaps with the central bank to hedge their external commercial
borrowings.
Both steps were part of a package announced to stabilise the
rupee. Analysts say they unlikely to push the rupee much higher
beyond its recent recovery against the dollar.
“We do not expect a significant appreciation in the INR,” on
the back of these inflows, analysts at Goldman Sachs said in a
note. The flows “are likely to be absorbed by the RBI.. through
rebuilding of its FX buffers, including unwinding a
significantly large short dollar forward book.”
Backed by RBI efforts to boost inflows and oil prices
sliding to three-month lows, the rupee has recovered to
94.50 per dollar after sliding to a all-time low of near 97
last month.
From a peak of $728.5 billion in March, India’s FX reserves
have fallen to $681.6 billion.
The RBI’s drive to rebuild its FX reserves alongside the
sizeable overhang of its forward book are expected to be a drag
on the rupee and keep its upside limited, according to Sakshi
Gupta, principal economist at HDFC Bank.
Shrinking the RBI’s forward book will require the central
bank to either buy dollars in the forward market or let its
outstanding contracts mature. Letting positions mature is
equivalent to an outright dollar purchase.
The dollar inflows could be used to run down forward book
maturities of up to one year, which stood at $44.6 billion as of
April 2026, Gupta said.
INTEREST PAYMENTS
The hedging of interest obligations on foreign currency
deposits is expected to further cap the rupee’s upside.
Assuming deposit inflows of around $50 billion, broadly
consistent with estimates from bankers, and applying a 6% annual
interest rate over an average maturity of four years, banks
would need to hedge nearly $12 billion via forward dollar
purchases, with implications for both spot and forward premiums.
The associated hedging demand is expected to steepen the
forward curve with banks seeking to hedge longer-term interest
payments, while the shorter tenure remains relatively anchored
amid ample liquidity, said Sameer Karyatt, executive director
and head of trading at DBS Bank India.