After cracking down on bond vigilantes, the Reserve Bank of India is training its guns on currency speculators.

The central bank has opened up a new front against currency manipulators who are eager to drive the rupee down against the US dollar by intervening in the forex forward swap market and allowing the rupee to appreciate in the past few weeks.

In the forward swap, the RBI has been selling the dollar to a bank and undertaking to buy it back at a premium.

The upshot: the forward premia on the dollar has started to nudge up sharply, stymieing plans by the currency manipulators to hammer the rupee’s exchange value.

The rupee has appreciated by 154 basis points between April 12 and May 7 and a report put out by the SBI Economic Research team theorises that the central bank has deliberately allowed this to occur because it wants to tamp down hard on any incipient signs of imported inflation — arising because of the recent spurt in metal and crude oil prices — before it snowballs into a major problem.

Over the past few weeks, there has been an excess supply of dollars in both the merchant market (both spot and forward) as well as the inter-bank market.

The SBI research report argues that the large supply of dollars will ensure that the rupee will appreciate from current levels and that this could potentially play to the advantage of the RBI in inflation management.

The central bank’s calibrated play in the forward swap market also ensures that it does not lead to an alarming surge in rupee liquidity as the purchase of dollars from the spot market leads to the release of rupees into the system.

The rise in inflows had also seen a spike in near-term dollar rupee forward premium. Last week, the one- month premium hit 10 per cent on an annualised basis.

However, by the end of the week it had softened to 5.27 per cent.

While the RBI’s strategy has been working for now —the jury is out on whether it can continue to “lean into the wind” and for how long.

The SBI report suggests that the rising forward premia makes the carry trade (a strategy where an investor borrows funds in a country where interest rates are low and funnels it into a market where the interest rates are higher) lucrative and this would lead to continuation of strong inflows which again leads to further currency appreciation and, therefore, greater liquidity overhang.

“In the end, there could be limits to sterilised intervention and rise in forward premia beyond a threshold,” the report said while adding that high premia also deters importers from hedging their dollar positions.

“Looking at the data, it appears that the RBI has been intervening heavily in the forward market. From a net

seller of dollar forward contracts in July 2020, it has turned into a net buyer of dollar forward contracts and its outstanding position is $47.3 billion in January 2021. The maturity breakdown shows that the RBI has the highest residual maturity in the more than 3 months and less than 1 year bracket of the amount equivalent to $44 billion,” says the report.

Market mavens believe that the central bank will continue with its strategy to rein in the currency manipulators even though this could make things a little rough for exporters who would like to see a weaker rupee in order to price their goods competitive.

Speaking to The Telegraph, Anindya Banerjee, DVP, currency derivatives & interest rate derivatives at Kotak Securities, said that

the RBI may have to continue intervening in the forward markets.