RBI's $32 Billion FX Inflows Yet to Ease Rupee, Banking Liquidity Pressures

Reserve Bank of India Governor Sanjay Malhotra said the various measures rolled out by the central bank have helped banks pull in $32 billion in foreign currency inflows.

However, this has still not translated into a meaningful improvement in the RBI's forex reserves or in rupee liquidity within the banking system, according to a Bloomberg report.

The rupee's reaction this time has been far more subdued than in 2013 when a comparable deposit push saw the currency gain over 10% within the first 37 days of the announcement.

Rupee's Response Has Been Muted

The rupee has rebounded only about 3% from its record low in May, with those gains since fading as tensions in West Asia weighed on the currency again. The RBI has sold dollars in recent sessions to support the rupee, according to traders.

Barclays Plc strategists, including Lemon Zhang, said that the rupee remains sensitive to crude prices, and that the deposit push offers only limited support since it doesn't directly affect the forex market, as per the Bloomberg report.

Barclays expects the rupee to weaken further and is maintaining a long Chinese yuan-rupee trade, per the report.

RBI's Forex Assets Lag the Deposit Buildup

Reportedly, the data show the RBI's foreign currency assets have risen by just $7.6 billion since the central bank's June 5 announcement, as of July 17, well short of the $32 billion raised through the deposit schemes.

State Bank of India Chief Economic Advisor Soumya Kanti Ghosh said that the gap could be a reporting-lag issue, since banks can swap their FCNR deposits with the RBI only on designated days each week, while the central bank updates its forex asset data every Friday.

Ghosh added that the RBI may also be using part of the inflows to unwind some of its $28 billion net short position in the up-to-three-month forward book. While the Citigroup Inc. flagged that banks could be actively hedging expected coupon payments as well.

Liquidity Squeeze Persists

Cash conditions in the banking system remain tight despite the inflows, as the RBI continues selling dollars to defend the rupee, a move that drains rupee liquidity, while injecting funds back in through repo operations, Bloomberg reported.

Puneet Pal, head of fixed income at PGIM India Mutual Fund, said that the FCNR flows haven't meaningfully eased banking liquidity so far, given the central bank's ongoing FX intervention, its management of short-dollar forward positions, and a rise in currency in circulation.

Axis Mutual Fund expects the liquidity surplus to widen substantially in the coming months, according to Bloomberg, with roughly $40 billion of the inflows likely to go toward offsetting the RBI's short-dollar forward book, and the remainder adding directly to system liquidity.

Borrowing Costs Have Already Eased

Banks had increasingly turned to costlier short-term borrowing as deposit growth failed to keep pace with credit growth, but funding costs have come down since the FCNR measures took effect.

The one-year certificate of deposit (CD) rate has fallen to about 7%, down from a two-year high of 7.96%, according to FBIL data compiled by Bloomberg.