RBI sells $8 billion: Why is the rupee still under pressure?

The Reserve Bank of India sold an estimated $8 billion to $15 billion in the foreign exchange market during the week ending September 4, according to six bankers cited by Reuters.

The intervention helped the rupee strengthen to an over two-month high of 94.2850 against the US dollar on September 3, recovering from its record low of 96.96 reached in May.

One banker estimated that the RBI sold around $15 billion during the week, while another put the figure at roughly $10 billion-$11 billion. The latter estimate would be at least three times the RBI's estimated dollar sales in the previous week.

The RBI did not immediately respond to a request for comment.

Large dollar inflows give RBI more room

The central bank's ability to intervene has been supported by substantial dollar inflows generated by recent policy measures.

The RBI's discounted hedging facility for overseas borrowings by state-run companies and banks, along with a free hedging facility allowing banks to raise overseas foreign-exchange deposits, has attracted more than $136 billion in inflows.

Bankers said these flows have provided the RBI with greater room to sell dollars and support the rupee.

India's foreign-exchange reserves stood at a record $740.8 billion as of August 21. J.P. Morgan estimated that reserves may have subsequently crossed $750 billion.

Why RBI is selling dollars

The RBI's intervention is aimed at managing excessive rupee weakness rather than necessarily initiating a sustained appreciation cycle.

Importers have increased forward dollar purchases to protect themselves against further rupee depreciation, while exporters have been holding back dollar sales in anticipation of more favourable exchange rates.

Analysts therefore expect the rupee to remain within a relatively narrow range rather than entering a prolonged strengthening cycle.

Goldman Sachs expects stronger external balances to support the currency but does not anticipate a sustained appreciation trend. It also expects the RBI to use future dollar inflows to reduce its forward foreign-exchange liabilities.

Dollar sales drain rupee liquidity

RBI intervention in the currency market also has an impact on India's banking system.

When the central bank sells dollars, it absorbs rupees from the banking system. This comes as surplus banking liquidity has already reached record levels.

India's banking-system liquidity surplus rose to Rs 10.73 trillion on Friday, creating concerns that overnight borrowing rates could fall below the RBI's policy rate.

Such a situation could weaken the transmission of monetary policy by effectively easing financial conditions.

RBI turns to reverse repo operations

The central bank has responded to the excess liquidity through cash-absorption operations.

The RBI received bids worth Rs 2.59 trillion for a 30-day variable-rate reverse repo operation. It subsequently announced another overnight operation worth Rs 5 trillion.

The operations allow banks to park excess funds with the central bank and reduce liquidity circulating through the financial system.

However, traders are watching for signs that the RBI could take stronger measures if liquidity remains excessive.

Bond markets remain cautious

Indian government bonds were largely subdued on Monday after a technical issue affected participation in the RBI's longer-duration liquidity withdrawal operation.

The benchmark 6.94% 2036 government bond yielded 6.9643% at 11:15 am IST, compared with 6.9625% at Friday's close.

Market participants are concerned that the RBI could consider measures such as foreign-exchange sell/buy swaps, open-market bond sales or an increase in the cash reserve ratio if existing operations fail to absorb sufficient liquidity.

Such steps could tighten financial conditions and affect the recent positive sentiment created by RBI policy measures.

Oil prices add to pressure

Global oil prices are another factor complicating the outlook for the rupee and Indian markets.

Brent crude rose 0.8% to around $97 a barrel in Asian trading. Higher oil prices can increase India's import bill and put pressure on the country's external balances and currency.

Investors are also watching US and domestic interest-rate expectations, which have contributed to caution across India's bond and currency markets.

The latest intervention highlights a challenge for the central bank: supporting the rupee while preventing excess liquidity from weakening monetary-policy transmission.

Large dollar inflows give the RBI more foreign-exchange ammunition, but selling those dollars injects rupees into the financial system. The central bank then needs to absorb that rupee liquidity through reverse repos and other operations.

Why the rupee's recovery may not last

The rupee's move from 96.96 in May to 94.2850 in early September represents a significant recovery, but analysts do not view it as evidence of a lasting appreciation cycle.

India remains exposed to oil prices, global bond yields, capital flows and the dollar's international strength. At the same time, importers' demand for dollars and exporters' reluctance to sell them can limit the currency's gains.

The RBI therefore appears focused on managing excessive volatility and disorderly moves rather than targeting a specific rupee level.