Rupee set to rally as RBI tightens foreign-exchange rules

The Indian rupee is expected to rally at Monday's open after the Reserve Bank of India moved to curb dollar demand and speculative activity in the foreign-exchange market. Traders expect the currency to strengthen about 1% to 95.60-95.90 per dollar, against a close of 96.73 on Friday.

The central bank said on Saturday that users would no longer be able to rebook cancelled rupee-linked foreign-exchange derivative contracts. It also lowered the threshold at which transactions require an established underlying exposure, and required banks to set aside 20% cash against certain FX contracts. According to traders, the changes could raise the cost of hedging against rupee weakness.

The measures are expected to alter corporate hedging strategies by lifting banks' costs on FX forward contracts, which are likely to be passed on to clients. That is expected to temper corporate demand for dollars. In addition to targeting importer demand, the RBI has opened a special window through which oil marketing companies can buy dollars directly from the central bank, diverting those purchases away from the regular market.

Writing in a note, Mitul Kotecha, head of FX and EM macro strategy Asia at Barclays, said the RBI had moved from signalling that the rupee's weakness may be excessive to directly restraining dollar demand and speculative activity in the FX market. The measures change where and when dollars are purchased rather than the underlying demand from oil imports, trade flows and capital outflows, he said, adding that the outlook remains for an orderly depreciation of the rupee.

On forward premiums, Kotecha said the 20% cash set-aside requirement would make forward hedging more expensive for importers and could push up the premiums they pay. From the interbank market's perspective, lower demand for forward dollars from importers could pull premiums down, while exporters' hedging activity is not affected by the measures. Wider balance-sheet costs, reduced liquidity and the RBI's management of its own forward book could nonetheless push pricing in the opposite direction, he said.