The Reserve Bank of India held a net short dollar position of $239 billion in the forward market as of September, and the need to unwind it will limit how far the rupee can rise even as foreign money returns, IDFC First Bank's economic research team said in a report published on Monday.

For investors in Asia, the report explains why a rupee that has already recovered sharply since early October may not run much further. As the RBI's forward contracts mature, the central bank will have to buy dollars to settle them, absorbing part of any rise in capital inflows. The same commitments also limit how many dollars the RBI can sell in the spot market to defend the currency if pressure returns.

RBI forward book and the swap windows

About $40 billion of the forward book matures within a year, $56 billion in one to three years and $143 billion in three to five years, according to the report as carried by PTI. The longer-dated positions are mostly tied to the RBI's swap window for FCNR(B) deposits, the foreign currency accounts that banks offer to nonresident Indians.

Those windows did a lot of work this year. The FCNR(B), external commercial borrowing and overseas foreign currency borrowing windows drew a cumulative $150 billion, the report said. India's balance of payments showed a $65 billion surplus in the first half of the fiscal year that began in April. Without the swap windows, IDFC First Bank estimated, the underlying position would have been an $85 billion deficit.

The money has to be repaid over three to five years. IDFC First Bank expects the RBI to shrink the forward book gradually.

The cushion is also thinner than it looks. Import cover from unencumbered reserves fell to about seven months in October from 10 months a year earlier, the report said. India's foreign exchange reserves fell by $2.691 billion to $717.056 billion in the week ended Oct. 30, according to RBI data released on Friday.

Rupee recovers after the October rate increase

The rupee settled at a provisional 93.93 per dollar on Monday, up 5 paise on the day, according to PTI. Softer crude prices, foreign fund inflows and hopes of calmer relations between the U.S. and Iran supported the currency. On Friday it had gained 52 paise in a single session as the dollar weakened and domestic stocks rallied.

That is a long way from early October. On Oct. 7, the RBI raised its repo rate by 25 basis points to 5.50%, its first increase in nearly four years, and changed its stance to "calibrated tightening." The rupee closed at a provisional 96.78 that day after coming close to its record low of 96.96. Governor Sanjay Malhotra said at the time that the currency may be undervalued and that the central bank would work to limit excessive volatility. Monday's close was about 2.9% stronger than the Oct. 7 level, by a Capital Times calculation.

Foreign investors have returned to Indian equities. Foreign institutional investors bought 13,749.82 crore rupees of stocks on Friday, PTI reported, after buying 14,974.68 crore rupees on Thursday. In October, by contrast, foreign investors were net sellers.

The RBI has also cut demand for dollars in the spot market. A special window for oil marketing companies and a Foreign Exchange Risk Reserve for importers have eased pressure, the report said. The net client forward gap, a gauge of hedging demand, fell to $17 billion in October, a 12-month low, from $197 billion over the first seven months of the fiscal year. IDFC First Bank warned that importers could start hedging heavily again if traders expect the rupee to weaken.

Forecasts and the rate outlook

IDFC First Bank expects the rupee at 92 to 94 per dollar by December, 94 to 95 by March 2027 and 96 by June 2027. Other strategists also expect the currency to weaken again as oil and outflows weigh on it.

The bank sees room for near-term gains if tensions between the U.S. and Iran ease, if U.S. artificial intelligence stocks correct and send money toward other markets, or if foreign portfolio inflows continue. Competition from the U.S. for global capital and high U.S. Treasury yields could limit them.

Oil is the main variable. IDFC First Bank expects India's crude basket to average about $85 a barrel for the rest of the fiscal year, compared with $102 in the first seven months. Brent crude traded at $97.53 a barrel on Monday, according to PTI. An agreement between Washington and Tehran could push prices lower and help the rupee.

On rates, the bank expects the RBI to raise the repo rate by 25 basis points in December and again in February, with a possible final increase of 25 basis points in April. Retail inflation was 4.82% in August, above the RBI's 4% target for a third straight month, and the central bank raised its inflation forecast for the fiscal year to 5.2% in October. India's October consumer price data are due this week.

Dilip Parmar, a senior research analyst at HDFC Securities, put support for the dollar at 93.50 rupees and resistance at 94.30, PTI reported.