Protecting the Falling Rupee

The rupee plunged to a new low last week. It closed at 77.46 per dollar Monday, breaking its erstwhile record of 76.97 reached on March 7. The next crucial level for the currency is seen in the range of 78-78.50 a dollar.

The central bank's calibrated intervention in the currency derivatives markets Tuesday salvaged the rupee from further record lows.

The Reserve Bank of India (RBI) is said to have sold dollars in the futures market and the offshore non-deliverable forwards (NDF) markets to prevent a drawdown for now on its foreign exchange reserves that are just shy of $600 billion currently.

"We are witnessing a combination of avenues in the central bank intervention strategy as the rupee slides," said Bhaskar Panda, executive vice president, HDFC Bank. "Such a strategy may be aimed at protecting the forex reserves for now amid the global turbulence."

Rupee likely to depreciate even more

Not just the RBI, economists are also  concerned about the falling rupee. According to Mythili Bhasnurmath Consulting Editor, ET Now “as per RBI’s own calculations, almost every 5% depreciation in the rupee adds about 10-15 bps to the inflation. So given the fact that inflation  is already very high and the RBI has been quite late to play catch up as far as raising interest rates to tackle inflation is concerned, going forward the outlook is not too good for the Indian rupee.”

India more vulnerable because it import almost 80% of  crude: Other than India, Asian currencies have also been hit. But  “in the Indian context, falling rupee  makes us a little more vulnerable than other Asian economies because we import almost 80% of our crude and crude prices are not coming down at all. So that is putting pressure on our current account deficit and that clearly is a sign of an economy which is not doing particularly well on the external front. That makes people more nervous and which is why the rupee is perhaps likely to depreciate even more in the coming days.”

There is nothing much that the Reserve Bank can do except to ensure that the spikes are not as sharp as they have been last week.  “They can only try and smoothen the decline and fortunately for us we have forex reserves though the reserves have also fallen to less than $600 billion.”

Biggest impact would be on inflation: According to Bhasnurmath   the biggest impact on a falling rupee “really would be on inflation. At a time when inflation is already very high, we saw March figures of 6.95-7% and in April, inflation is expected to have touched 7.5%.

Good forex reserves: The rupee is seen as a symbol of the Indian economy’s strength. But “luckily we have the kind of forex kitty which we did not have in the past. It was over $600 billion and now it has come to be just a little short of $600 billion. So we have the forex reserves but whether it makes sense to intervene and try to prevent the underlying trend is a big question mark. Normally, no central bank intervenes against the market…..

“Fortunately for the RBI, this comes at a time when the RBI is consciously trying to tighten monetary policy also. So, there is no conflict but the biggest worry is not just in terms of volatility and that is not doing good for either exporters or importers, the bigger worry really is what it does for inflation…..”

Hardening of US interest rates and elevated crude oil prices exacerbating problems

The two basic elements, writes the Hindu BusinessLine “that shaped India’s rupee, external account and inflation crisis of mid-2013 are very much in our midst today -- namely, the hardening of US interest rates and elevated crude oil prices, at well over $100 a barrel. India, whose petroleum imports account for a fifth or more of its total import bill at prices of over $80 a barrel, inevitably runs into external account turbulence when energy prices rise. An increase in crude prices widens the current account deficit and weakens the rupee, while a spike in US interest rates encourages capital outflows and hurts the rupee further. A crisis can set in, if not properly managed. This nearly happened in 2013, when the rupee fell from about 56 to the US dollar at the end of May to nearly 69 three months later, a fall of nearly 25 per cent, while the CAD touched 4.8 per cent of GDP in FY14……But today, India is in a much better situation, even as its rupee and the CAD are coming under a bit of pressure.

Healthy forex reserves, but no room for complacency

“The rupee has fallen by about 6 per cent since end-January, but has since then recovered. As the Economic Survey 2021-22 notes, India’s reserves can cover about 14 months’ imports, against 7.8 months in FY 14 (the taper tantrum year), even though forex reserves have fallen from $633 billion as on December 31, 2021 to below $600 billion today. In absolute terms, they are double the levels of FY 2014. The external debt to GDP ratio remains unchanged at about 20 per cent. Yet, there can be no room for complacency. With the US treasury yield rising by over 80 per cent from 1.72 per cent on March 1 this year to 3 per cent now, capital outflows arising out of interest arbitrage could pick up. As the RBI Annual Report for FY14 shows, an interest rate differential of about 6.5 percentage points helped, among other factors, to bring down the rupee value from 68 to a dollar in September 2013 to 60 to a dollar in July 2014. Today, the interest rate differential is just over 4 percentage points, a level that can be sustained if the CAD is kept in check, thereby necessitating lower capital inflows to keep the external account in balance. However, the CAD is expected to end up at $100 billion in FY23 (about 3 per cent of GDP), translating into a merchandise trade deficit of about $280 billion, against $192 billion in FY22. While more rate hikes seem hard to avoid, other steps can be taken to contain capital outflows. Realistically speaking, lowering the trade deficit through lower imports seems impossible in the short run.”

The Hindu BusinessLine suggests the “Centre should seek to step up FDI flows by removing bottlenecks to investment. It can go slow on signing more free trade pacts, so that it can raise tariffs on non-essential imports if required….”

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