FOCUS: RBI’s defence of rupee from record low not just about a level
Informist, Friday, Sep 29, 2023
By Pratiksha and Kabir Sharma
MUMBAI/NEW DELHI – This month was witness to the Reserve Bank of India's relentless efforts to keep the rupee from hitting a record low. But the central bank's intervention strategy in the foreign exchange market may have more to it than meets the eye.
With the RBI already grappling with an inflation rate that is above its tolerance band, a sudden jump in crude oil prices has emerged as another impediment. Prices of crude oil have surged almost 25% since June due to a bleak supply outlook after Saudi Arabia and Russia extended their production cuts till the end of this year.
While Saudi Arabia rolled over its voluntary cut of 1 mln bbl a day, Russia announced a reduction of 300,000 bpd.
Considering India depends on imports to meet about 80% of its crude oil requirements, an increase in the country's import bill will weigh on the Indian currency, which in turn will lead to risk of imported inflation.
As the RBI looks to limit the extent of imported inflation, it has been actively intervening across the foreign exchange market, including the spot and the offshore non-deliverable forwards market.
So far this month, the rupee has depreciated 0.5% against the greenback. During the same period, other Asian currencies fell 0.6-4.0% against the dollar. The Philippine peso was the only emerging market currency that fared better than the Indian unit.
Lately, RBI's presence has been felt every time the rupee has moved below 83.15-83.20 a dollar, nearing its record low level of 83.29. As of Sep 22, India's foreign exchange reserves were at $590.70 bln, down $18.32 bln from the recent high of $609.02 bln on Jul 14.
According to Nomura, a 10% rise in oil prices will raise India's CPI inflation by 25 basis points on an average. Though headline inflation based on the CPI moderated to 6.83% in August from a 15-month high of 7.44% in July, it has remained outside the medium-term target range of 2-6% for the last two months.
"The imperative for the RBI to prevent a sharp fall in the rupee stems from high domestic inflation, and rupee weakness has an inflationary impact," said Dhiraj Nim, forex strategist/economist, Global Research at ANZ Banking Group. "By my estimate, for a similar proportionate rise in USD/INR and Brent crude, the former is twice as inflationary as the latter in India's case."
The International Energy Agency has said it foresees a substantial deficit in the crude oil market through Oct-Dec due to the extension of cuts by Saudi Arabia and Russia. The surge in crude oil prices will add to the pressure on trade deficit for the rest of the current financial year, analysts say.
India's current account deficit widened to $9.2 bln in Apr-Jun from a seven-quarter low of $1.3 bln in Jan-Mar, primarily on account of a higher trade deficit.
One development that has made the RBI's job easier is the inclusion of Indian government bonds in JPMorgan's Global Bond Index – Emerging Markets. The central bank can now spend the dollars at its disposal with a sense of comfort, considering the index inclusion will pave the way to considerable foreign fund inflows into the Indian debt market, which the RBI can later absorb to replenish its foreign exchange buffer.
Analysts at HSBC have projected $30 bln of inflows into government bonds from the inclusion in JPMorgan's index.
"RBI wants to limit volatility on both sides, they try to fill up reserves as soon as it appreciates and try to smoothen the fall when it depreciates. They are limiting the move (in rupee)," said Gaura Sen Gupta, economist, IDFC First Bank.
However, the viability of RBI's intervention strategy is uncertain and traders need to place their long bets on the local currency with caution. Historically, traders haven't really fared well when the currency has sailed against the wind for a long period.
Case in point – last year, when the central bank went all guns blazing to protect the 80-per-dollar level for the rupee, the result was the rupee moving from 80 to 83 a dollar in just a month.
Considering the current headwinds to the domestic unit are not expected to go away easily, one can't rule out the possibility of a record low for the rupee in the near future.
"There certainly are risks that the rupee could weaken to another record low because dollar strength is not giving up while oil prices have risen as well," Nim said.
With the supply outlook for crude oil expected to remain bleak, the rally in oil prices may persist in the near term. Meanwhile, the dollar index is also unlikely to lose steam in keeping with the 'higher for longer' interest rate stance of the Federal Reserve.
Considering the central bank can only protect the currency for so long, it may have to lower its guard against currency depreciation if any of these risk factors aggravate unprecedentedly.
Looking at the tightrope the central bank is walking, the upcoming monetary policy statement on Oct 6 will be crucial in getting a sense of the apex bank's thinking on the Indian currency's movement. End