Barely a month after the Indian rupee hit a two-month high and showed signs of stabilising after its brutal fall this year, the currency is at risk from a re-emergence of heavy demand for dollars from oil importing firms.
As the rupee hit a 9-week low against the dollar on Wednesday, extending its drop over four trading sessions to 2 percent, the overriding fear in Indian markets was the return of dollar buying by oil companies, coupled with concerns the central bank will soon wind down a special dollar facility for these firms.
The U.S. dollar's rally this week on fresh expectations of the Federal Reserve scaling back its stimulus have also been factors pressuring the rupee, as well as Indonesia's rupiah and other emerging markets exposed to foreign capital flows.
But the re-emergence of dollar buying by oil importers has unnerved analysts, reminding them of the fragility of the rupee and its vulnerability to a wide current account deficit.
The three state-run oil marketing firms require an estimated $350 million a day, accounting for the bulk of dollar demand in India's markets.
The Reserve Bank of India had provided these companies with a special dollar swap window to borrow dollars as part of a package of measures to defend the rupee as it plunged to a record low in late August.
The swap window is expected to close at the end of November as the central bank gradually reverses its drastic rupee-defence policies. Traders fear that some of the early 3-month swaps these companies had entered into with the central bank would fall due in December, requiring them to buy dollars from the market.
"Oil companies are buying forward dollars particularly in near-month tenors to repay the central bank for the dollar swap window," said a dealer with a state-run bank who declined to be named as he was not authorised to speak to the media.
"We are seeing some demand in the 3-month tenor but I wouldn't say it is too big," said a forex dealer with another state-run bank.
The rupee weakened to 63.90 per dollar on Wednesday, before recovering some ground on suspected central bank intervention. It is still some distance away from the August record low of 68.85. But, having lost 13.4 percent of its value against the dollar since the start of this year, the rupee's slide this week has analysts worried.
The currency hit a two-month high in October, stabilising after a series of measures by the RBI and government to attract foreign currency inflows, deter speculators and discourage the import of gold.
Deutsche Bank said in a report this week November would bring more nervousness to the rupee market. Among factors that would contribute to the jitters would be worry that the slight improvement seen in India's yawning current account deficit cannot be sustained.
The unwillingness of foreign investors to keep funding vulnerable countries and the unwind of the RBI's swap facilities would also undermine the rupee, they wrote, noting expected levels of rupee volatility, or vols, had already risen.
"We close out our tactical long in rupee and turn neutral. The RBI-facilitated, low-volatility spot regime is coming to an end with the reintroduction of oil demand to the market," Deutsche said.
Although the swap window for oil importers has not officially been closed, the country's economic affairs secretary Arvind Mayaram last week confirmed what rupee traders had heard, that state-run oil companies were back to buying about 30 percent to 40 percent of their dollar needs from the market.
Newly appointed RBI Governor Raghuram Rajan has been rolling back some of the exceptional rupee defence measures the central bank took in mid-July, including hefty increase in its emergency funding rate. Analysts expect the oil swap window would also soon be wound down.
The expectation that they would need far more dollar funding to repay the RBI when the swaps expire has pushed the rupee down in forward markets. Traders at state-run banks said the sharp rise in dollar-rupee future premium was partly due to these oil companies hedging their swap repayment obligations.
The forward market was pricing the rupee at 64.26 per dollar by the end of December, nearly one percent weaker than levels on Wednesday.
But the pressure on the rupee would ultimately be a function of how much oil the country needs in the months ahead and how much of the dollar needs have been hedged pre-emptively.
HPCL, one of the state-run oil marketing companies which had borrowed dollars via the RBI's swap window said it has hedged its dollar obligations.
"Our current requirement is minimal because our repayment obligations have been secured some time ago because of hedging for these months," said HPCL Head of Finance K. V. Rao.
"Our inventory position is also very good, so we may not go for large amount of imported crude which requires immediate payment."
(Additional reporting by Nidhi Verma in NEW DELHI)