India’s exchange rate may be showing signs of getting infected by the coronavirus outbreak, but in reality, the illness it suffers from is called intervention.

The rupee has weakened around 0.2% since the outbreak of the epidemic in China last month. Its Asian peers have performed much worse, with the Singapore dollar, the Malaysian ringgit and even the Thai baht losing more than 2%. The Chinese yuan has been the worst hit, since the country is the vortex of the crisis.

If we take a longer-term trend, the picture changes. Since July last year, the Indian currency has dropped more than 3%, while many of its Asian peers have been much better off. The rupee becomes one of the worst performers among Asian currencies if we take a six-month trend.

Graphic by Naveen Kumar Saini/Mint
Graphic by Naveen Kumar Saini/Mint

This is because of a single participant in the market—the Reserve Bank of India (RBI). The central bank has been incessantly buying dollars, soaking up whatever foreign inflow entered Indian shores. It has swallowed $15.5 billion from the spot forex market between July and November, and currency dealers believe it hasn’t stopped yet.

RBI even intervened in the forward dollar market, purchasing contracts that allow it to buy greenbacks at a future date. The accompanying chart shows the extent of central bank intervention.

Ironically, RBI has made it easy for dollars to come into the country. In the pursuit of inclusion in global bond indices, the central bank has invited foreign investors to take a larger bite of Indian bonds. But while RBI is opening up and welcoming foreign inflows, it is also doing everything it can to prevent the rupee from appreciating.

The central bank has its reasons for its death grip on the exchange rate. India’s economic growth is estimated to fall to a multi-decade low on a nominal basis in FY20. A country’s exchange rate derives strength from its economic growth and therefore, the rupee’s weakness is warranted. Since dollar inflows seldom follow only the growth factor, RBI seems it fit to absorb them, as a slowing economy has little capacity to do so. Dollars when left alone tend to chase fewer assets, which in its worst form creates a bubble.

Another reason for RBI to keep a grip on the rupee is competitiveness. The real effective exchange rate, based on a trade-weighted index of 36 currencies, shows the rupee is overvalued by a stark 17% as of December, although economists say the overvaluation is mild once the Chinese yuan is taken out of the mix.

“The RBI’s view seems to be that the rupee’s fair value is somewhere in the region of 71-72 per dollar. The rupee has to be relatively weak for a competitive advantage vis-à-vis trading partners and leaving it to the forces of the market is not appropriate," said an economist, asking not to be named. The rupee ended at 71.29 to a dollar on Tuesday.

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