RBI sells dollars directly to oil importers; kicks the can down the road

India's central bank, the RBI, is trying new measures to stabilize the rupee. One of the key sources of pressure on the currency is the nation's need to import fuel. Oil companies have to buy dollars (sell rupees) in order to purchase crude oil in the international markets (including from Iran) to meet the nation's massive energy needs.

Rather than having these oil firms go into the foreign exchange markets to buy dollars (which have become more expensive by the day) the RBI wants to sell them dollars directly. And it would do so at some rate which is better than what these firms can get in the spot market. The goal is to keep these large importers from flooding the market with rupees.

Reuters: - The Reserve Bank of India will provide dollars directly to state oil companies in its latest attempt to shore up a currency that has slumped to a record low, reflecting the stiff economic challenges facing the country in an uncertain global environment.

The Reserve Bank of India announced late on Wednesday a special window "with immediate effect" to sell dollars through a designated bank to Indian Oil Corp Ltd, Hindustan Petroleum Corp, and Bharat Petroleum Corp "until further notice".

The RBI last opened such a window during the 2008 global financial crisis, although it had been widely expected to re-implement the measures after last month telling oil companies to buy dollars from a single bank.

The steps are the latest in a series of extraordinary measures undertaken by the RBI to combat a currency fall of more than 20 percent this year, by far the biggest decline among the Asian currencies tracked by Reuters.

The announcement of this decision stabilized the rupee - for now.

USD/INR (source: Investing.com)

Many observers view this action as having only a temporary effect. According to Reuters, the RBI will "sterilize" the dollars it provides to India's large energy firms. As it sells dollars to the oil companies, it will simultaneously buy dollars in the forward market to replenish its foreign reserves in the future. The central bank is doing what it can to avoid a repeat of 1991, when foreign reserves dwindled - forcing India to seek help from the IMF (see post).

Reuters: - Officials familiar with RBI thinking told Reuters the dollar sales for state-run oil companies would be offset by positions in forward markets.

That means that although the RBI would need to dip into its currency reserves, it had the prospect of replenishing the lost dollars at a future date by redeeming the forward contracts from oil companies when the rupee stabilises.

The offsetting positions would essentially make these dollar loans, designed to reduce concerns about reserves that at $279 billion, cover only about seven months of imports.

The action further cements the role the central bank is taking to combat the fall in the rupee, as the government has yet to unveil steps that can convince markets it can stabilise the rupee and attract foreign investment.

However when those forwards mature, the RBI will take the dollars back and release the rupees into the market, putting downward pressure on the currency again. Of course the central bank can roll the forwards for a long time, but the more dollars it sells to the oil firms, the more dollars it will need to purchase in the forward market. The RBI is simply kicking the can down the road, creating a growing overhang of rupees that will eventually have to hit the market (as RBI gets the dollars back.)  The hope is that by then the pressure on the currency won't be as great as it is now.

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