BackWhy RBI finds it tough to let go of its hold on rupee
The rupee has underperformed emerging market peers despite the markets attracting record dollars, because the Reserve Bank of India soaked up most of them. Amid the debate on whether RBI should temper down its intervention, Mint explores why it could be tough.
PremiumThe rupee has underperformed emerging market peers despite the markets attracting record dollars, because the Reserve Bank of India soaked up most of them. Amid the debate on whether RBI should temper down its intervention, Mint explores why it could be tough.
How has the rupee performed in 2020?
The Indian rupee was pummelled in the first few months of the year, with the pressure increasing manifold post-covid outbreak. The exchange rate depreciated over 6% in the first four months of 2020. Its Asian peers did slightly better. But emerging economies slowly opened up, and the advanced countries also eased restrictions. This, along with a dollar glut due to ultra loose monetary policies, led to a smart rebound in currencies. The rupee, however, has underperformed this recent rally. In fact, in year-to-date performance, the rupee is at the bottom of the pile among Asian currencies.
Why did the rupee lose out on the rally?
Market participants said it was due to RBI’s interventions. RBI buys or sells dollars through designated banks in the foreign exchange market. When the central bank believes that dollar inflows exceed the absorption capacity of the economy, it buys dollars. India’s economy is expected to shrink by at least 7.5% in FY21. So, logically, the economy is in no shape to absorb the dollar flows it has been getting. Ergo, the central bank has been soaking them up. So far in FY21, $27.6 billion flowed into equities, but $4 billion has left the bond market. But overall, inflows have been large enough for RBI to keep intervening.
Is RBI’s intervention in forex market strong enough?
RBI’s forex reserves have expanded by over $100 billion so far in 2020 through interventions. This is a record accretion, in a sign that RBI has had a strong grip on the rupee. As per its own data, it bought $73.4 billion between January-October, perhaps the highest ever in any year. Economists said without this intervention, there is a strong appreciating bias for the rupee.
Will RBI continue to intervene in market?
RBI has not spelled out its foreign exchange strategy, but economists expect it to continue. Although, RBI did say that an appreciating rupee helps keep inflation under check, its actions do not show that it prefers the rupee to gain. Macro conditions also warrant a weaker rupee as a rise in inflation makes the rupee overvalued against other currencies. Inflation erodes value of India’s assets, thereby reducing its appeal to investors. Further, a sharp appreciation of the rupee hurts export realizations, which India cannot afford.
What is likely to happen next year?
The rupee’s fortunes completely depend on RBI’s approach. It may have less reason to intervene next year as the economy is expected to rebound. Inflation may ease too, which is another reason to curb intervention. The global dollar liquidity is unlikely to reduce and may continue to flow into EMs, including India. While RBI may ease off intervention, it is unlikely to let go of the rupee. Median estimate of economists polled by Bloomberg shows that rupee may appreciate to 72 to a dollar by Q4 of 2021, a 2.5% gain from now.
Unlock a world of Benefits! From insightful newsletters to real-time stock tracking, breaking news and a personalized newsfeed – it's all here, just a click away! Login Now!
