Home / News / India /  RBI plan to boost forex tailwind for trade

The frenetic accumulation of foreign exchange may check the strengthening of the local currency and fuel Indian exports in the short term, experts said, with the central bank hinting that current reserves of $600 billion are sufficient to cover imports for a shorter duration than many other large economies.

The Reserve Bank of India’s (RBI’s) 16 June monthly bulletin said forex reserves crossed $600 billion, making India the world’s fifth-largest reserve holding country. However, RBI said this will still cover less than 15 months of projected imports, against Switzerland’s 39 months, Japan’s 22 months, Russia’s 20 months, and China’s 16 months. Since the publication of the bulletin, the reserves rose further to $608.08 billion as on 11 June.

“There is an intrinsic bias towards accumulation, which will have a residual impact on the rupee. There is a chance that the rupee will mostly underperform compared to emerging market peers even with healthy emerging markets flows," Madhavi Arora, lead economist at Emkay Global Financial Services, said over the phone.

A weak rupee may help increase exports, but rising inflation could play spoilsport.
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A weak rupee may help increase exports, but rising inflation could play spoilsport. (Photo: Bloomberg)

The shorter import cover warrants a pragmatic assessment of reserve adequacy on forex reserves, including exposure to valuation changes and market risk in a world of heightened global uncertainty, the bulletin noted.

The rupee closed at 73.86 per dollar on 18 June, strengthening after eight straight sessions of decline.

Arora of Emkay Global added that policymakers are trying to achieve export competitiveness using the nominal exchange rate route, as productivity dynamics cannot be improved immediately.

“The least that they could do is allow the currency to depreciate. Honestly, in the medium term, it is not your nominal exchange rate that will matter but your real exchange rate," she said.

However, experts cautioned that while a weaker rupee may aid in increasing exports, rising inflation could play spoilsport. For now, the monetary policy committee (MPC) is expected to be in a wait-and-watch mode and look through the surprise surge in retail inflation in May. Inflation measured by the Consumer Price Index (CPI) came in at 6.3% in May, above the Reserve Bank’s target band of 2-6%.

“Keeping your exchange rate undervalued helps your external sector at the expense of the domestic sector. It is basically trying to shift consumption away from the households to the external sector," said Anindya Banerjee, deputy vice-president (currency derivatives and interest rate derivatives) at Kotak Securities.

Banerjee explained that when the currency is strong, domestic consumption gets a boost, but when it is weak, it incentivizes exporters.

India’s exports expanded in May this year when compared with May 2019 in sectors such as engineering goods, petroleum products, iron ore, cotton textiles and drugs and pharmaceuticals.

The Reserve Bank added that engineering goods, accounting for nearly a fourth of the total exports, were massively affected due to demand and supply disruptions caused by the pandemic. However, this segment has bounced back, staging a smart recovery in recent months, surpassing pre-pandemic levels.

RBI governor Shaktikanta Das also alluded to a strengthening of the external environment and said it augurs well for India’s export sector. This comes at a time when urban demand has weakened following the second wave.

“Global demand conditions are expected to improve further, buoyed by fiscal stimulus packages and the fast progress of vaccination in advanced economies. India’s exports in March, April and May 2021 have launched into an upswing," Das said on 4 June.

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