The many wounds of a falling rupee and the eerie calm of RBI
Since nearly 50% of foreign exchange trade is offshore, the Reserve Bank of India knows how futile it is to try to stop the flight of hot money
The rupee’s nosedive to 71 to a dollar has understandably rattled investors. Domestic investors are worried that a depreciating currency adds to inflation and would eventually turn borrowings expensive. Foreign investors are already losing money on their rupee investments.
Bond yields have risen by 20 basis points, anticipating an interest rate hike induced by a weakening currency. Given that the denizens of the stock market are a mixture of the wounded and the rewarded, indices have chosen to largely ignore the currency hit. Nevertheless, the wind has gone out of the sails of many stocks due to the falling rupee.
The casualties of a falling rupee are many. Foremost are companies that have to contend with not just expensive imports that would eat into their margins but also expensive forex derivatives to hedge their balance sheet and borrowings.
The cost of hedging has gone up sharply in the last three months as shown in the adjoining chart. The Mumbai Interbank Forward Offered Rate (MIFOR) is a good indicator of hedging costs. This has risen by as much as 50 basis points since May. Forward premia have increased as well with the most-used one-year premium surging 30 basis points. No wonder importers are sticking to just near months like one- or three-month hedges.
One basis point is one-hundredth of a percentage point.
Companies not only have to hedge their business but also their borrowings. External commercial borrowings have grown sharply in the last one year as Tadit Kundu noted in a Mint story on 28 August. In the previous fiscal year, high domestic bond yields and loan rates had driven companies to borrow offshore.
It is obvious that a net importer like India will suffer if its exchange rate drops. Hence, investors are not pleased with the Reserve Bank of India’s (RBI’s) eerie calm over the currency’s deep dive. How can the central bank that guarded the 68-69 to a dollar level with ferocity just a few months back be blasé about the drop to the historic 71?
There is a reason for RBI’s composure. Since nearly 50% of foreign exchange trade is offshore, the central bank knows how futile it is to try to stop the flight of hot money. Perhaps it doesn’t want to, since the rupee’s fall has its roots in the carry-trade induced portfolio flows that India gleefully welcomed last year when its balance of payments was slowly degenerating. Now, it is payback time for the past imbalances.
To its credit, there is enough warning that RBI has given on the currency front so that companies are not caught unawares. It has reiterated the fact that the rupee is overvalued despite the steep fall, as is shown by the real effective exchange rate. In the annual report of fiscal year 2018, the central bank has said that currency depreciation may not decisively lead to greater competitiveness in the short term.
Even so, there doesn’t seem to be any signs of RBI pulling all stops to bring the rupee back.
So, importers have to lick their wounds and wait for the Indian currency to come up for air on its own.