India’s $32 Billion Forex Push Yet To Deliver Stronger Rupee Or Banking Liquidity

India’s efforts to increase foreign currency inflows have gathered pace, with Reserve Bank of India (RBI) Governor Sanjay Malhotra stating that banks have mobilised $32 billion under the special deposit measures announced earlier this year. Even though there have been sizeable capital flows, the rupee has been under pressure, while liquidity remains constrained in the banking system.

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The latest developments suggest that the benefits of the deposit mobilisation drive are taking longer to filter through the financial system, even as the RBI continues to manage currency volatility and liquidity conditions.

Rupee Response Remains Limited

The rupee has shown only a modest recovery since the RBI announced the deposit measures on June 5. After touching a record low in May, the domestic currency recovered by as much as 3%, but those gains have narrowed amid renewed geopolitical tensions in West Asia and a rise in the crude oil price.

According to a note by Barclays Bank Plc strategists led by Lemon Zhang, the deposit mobilisation programme offers only limited support to the rupee because it does not directly alter foreign exchange market dynamics. The brokerage added that the crude oil price continues to remain one of the biggest external factors influencing the domestic currency.

Market participants have also observed RBI intervention through dollar sales in recent sessions to contain excessive volatility in the foreign exchange market.

RBI’s Foreign Currency Assets Trail Inflows

Although banks have raised $32 billion under the schemes, the RBI’s foreign currency assets have increased by only $7.6 billion since the announcement, based on data available up to July 17.

State Bank of India Chief Economic Advisor Soumya Kanti Ghosh said the difference could reflect a reporting lag because banks are allowed to swap these deposits with the RBI only on designated days, while the central bank updates its foreign currency asset data every Friday.

A separate note from Citigroup Inc. indicated that part of the inflows may also be used to reduce the RBI’s short forward dollar positions or support hedging activity linked to future coupon payments.

Liquidity Conditions Continue To Stay Tight

Despite the increase in foreign currency deposits, banking system liquidity has not eased materially. The RBI has continued to inject funds through repo operations as dollar sales have absorbed liquidity from the financial system.

Puneet Pal, Head of Fixed Income at PGIM India Mutual Fund, said foreign currency non-resident (FCNR) inflows have so far had a limited impact on liquidity because of ongoing foreign exchange intervention, management of the RBI’s short forward positions and higher currency in circulation.

Axis Mutual Fund said a portion of the inflows could eventually improve liquidity after offsetting nearly $40 billion of the RBI’s short-dollar forward book.

Funding Costs Show Signs Of Easing

One area where the measures have had a visible impact is bank funding costs. According to Financial Benchmarks India Pvt. Ltd. (FBIL) data compiled by Bloomberg, the one-year certificate of deposit rate has declined to around 7% from a more than two-year high of 7.96% recorded in May.

The decline suggests funding conditions have started to improve, although the broader impact of the deposit mobilisation programme on the rupee, liquidity and the RBI’s foreign currency assets is likely to become clearer as the inflows are absorbed into the financial system over the coming weeks.