The Reserve Bank of India has decided to shift to a more constant pattern of intervention to support the currency over the past month, thanks to the level of foreign deposit inflows, whereas previously it would largely step in to curb bigger swings, according to a person familiar with the matter. The change in tack comes from the comfort provided by $73 billion of fresh money under RBI’s measures to attract dollars since June, they said, asking not to be identified discussing policy matters.
In one instance, the RBI spent $7 billion in just a day intervening in onshore and offshore markets as the rupee approached a record low. There are signs the strategy has brought more stability, with the currency’s near-term volatility falling close to a 10-month low.
The extra money strengthens the RBI’s hand just as pressure starts to mount again on Asia’s worst-performing currency this quarter. The respite in June is fading as higher crude prices add to the current account deficit while a narrowing interest rates differential with the US pulls capital from India’s markets. The question though is whether the more robust effort will be enough, when more than $700 billion of reserves have failed to convince investors that the rupee is undervalued.
“The RBI’s primary objective is to dampen volatility and the velocity of moves in either direction, rather than fundamentally altering the trajectory,” said Chandresh Jain, Asia emerging markets rates and FX strategist at BNP Paribas SA. Supported by the new flows, “the RBI has the capacity to maintain this stance for a period.”
The dollar-rupee one-month implied volatility is down about 100 basis points this month, compared with a six basis points drop in a global currency gauge. That has surprised market watchers who got used to more swings in the currency under RBI Governor Sanjay Malhotra.
“One can ask, how much stability they want to achieve,” said Rajeswari Sengupta, an associate professor at Indira Gandhi Institute of Development Research. Malhotra’s predecessor sought to keep the rupee steady toward the end of his tenure, “maybe under this governor, it means small amounts of depreciation,” she said.A spokesperson for the RBI didn’t respond to an email seeking comment.
The shift in the intervention pattern slowed the rupee’s depreciation but couldn’t reverse its trajectory. The currency has weakened 0.8% against the dollar this quarter, compared with a 5.2% decline in the January-March period when the Middle East war hit investor sentiment toward the fuel-importing nation.
BloombergDollar demand from importers has been dogged as they lock in future purchases to guard against rupee weakness. Monthly average forward dollar purchases so far this year have jumped 40% to $60 billion, according to Clearing Corp. of India data, which is used as a proxy for hedging by importers and exporters. In contrast, dollar sales rose 27% to $32 billion.
“What needs to be tackled is the relentless stream of dollar demand from importers and a lack of dollar selling from exporters,” said Ashhish Vaidya, head of treasury at DBS Bank Ltd. in Mumbai. “You need higher forward premia, driven by higher interest rates to correct that situation.”
That underscores the delicate balance the RBI must pull off as it weighs economic growth against currency defense. Unlike many of its peers, the central bank has so far refrained from raising rates as doing so might slow an economy facing headwinds from the Iran war.
Another variable is how the RBI tackles its future dollar-selling obligations of more than $100 billion. The recent inflows means it can let some of the near-term short-dollar forward positions mature without draining too much liquidity from the banking system. That’s because lenders are swapping the dollars they receive for rupees under the central bank’s concessional facility.
“It’s important the RBI draws a line in the sand for rupee in the near term, as there is a risk further fall in rupee could become self-fulfilling,” said Abhishek Upadhyay, an economist at ICICI Securities Primary Dealership.
