The Indian rupee's rally on lower oil prices is likely to be constrained by the central bank's unwinding of its sizable FX forward book and hedging of interest obligations on foreign currency deposits raised by Indian banks.
The Reserve Bank of India's short-dollar forward book is estimated to have ballooned to an all-time high of nearly $110 billion, according to two officials at foreign banks, up from $96 billion in April.
The surge follows persistent central bank intervention across both domestic forwards and non-deliverable forward markets to support the rupee.
The forward book is poised to expand further, with banks passing on the currency risk from foreign-currency inflows raised by them to the RBI via swaps. State-run enterprises and lenders are expected to add to this buildup through dollar-rupee swaps with the central bank to hedge their external commercial borrowings.
Both steps were part of a package announced to stabilise the rupee. Analysts say they unlikely to push the rupee much higher beyond its recent recovery against the dollar.
"We do not expect a significant appreciation in the INR," on the back of these inflows, analysts at Goldman Sachs said in a note. The flows "are likely to be absorbed by the RBI.. through rebuilding of its FX buffers, including unwinding a significantly large short dollar forward book."
Backed by RBI efforts to boost inflows and oil prices sliding to three-month lows, the rupee has recovered to 94.50 per dollar after sliding to a all-time low of near 97 last month.
From a peak of $728.5 billion in March, India's FX reserves have fallen to $681.6 billion.
The RBI's drive to rebuild its FX reserves alongside the sizeable overhang of its forward book are expected to be a drag on the rupee and keep its upside limited, according to Sakshi Gupta, principal economist at HDFC Bank.
Shrinking the RBI's forward book will require the central bank to either buy dollars in the forward market or let its outstanding contracts mature. Letting positions mature is equivalent to an outright dollar purchase.
The dollar inflows could be used to run down forward book maturities of up to one year, which stood at $44.6 billion as of April 2026, Gupta said.
INTEREST PAYMENTS
The hedging of interest obligations on foreign currency deposits is expected to further cap the rupee's upside.
Assuming deposit inflows of around $50 billion, broadly consistent with estimates from bankers, and applying a 6% annual interest rate over an average maturity of four years, banks would need to hedge nearly $12 billion via forward dollar purchases, with implications for both spot and forward premiums.
The associated hedging demand is expected to steepen the forward curve with banks seeking to hedge longer-term interest payments, while the shorter tenure remains relatively anchored amid ample liquidity, said Sameer Karyatt, executive director and head of trading at DBS Bank India.
