Rupee At 80/Dollar: Keeping A Macro ‘Escalation Ladder’ Ready
India is far away from needing to garner FCNR(B) deposits, which are also likely to be costlier now, writes Rahul Bajoria.
Recent headlines have been talking about the Indian Rupee hitting a new low. Concerns over the Rupee’s recent depreciation are understandable, as market watchers and the public at large tend to focus on the Dollar/INR cross, which has moved from 72 last year to around 80 this year. But if one looks at other currency crosses, like the Euro/Rupee, the story is completely different. The weakening of the Rupee over time is not a new phenomenon and is as anticipated.
This Is Not 2013
Still, the memories of the 2013 “taper tantrum” are perhaps front and centre, and foreign exchange markets are nervous, given the widening current account financing gap, and lower foreign reserves. However, if one steps back and looks at India’s macro fundamentals, they appear to be in better shape now than in the recent past, especially as global macro fundamentals have deteriorated. India’s growth remains strong, its inflation differential versus other economies is contained, and its foreign exchange reserves, though declining, remain considerable. Even when viewed through a real valuation lens, the Rupee on a real effective exchange rate basis does not look overvalued.
Then why is the RBI intervening so strongly to stall the Rupee’s depreciation? The answer lies in the sources of inflation.
Unlike the 2009-13 high inflation period, when Rupee weakness was an ancillary contributor to the inflationary cycle, the situation is different today.
The RBI perhaps rightly believes that in an environment of high global commodity prices, economic agents will be more sensitive to exchange rate depreciation. Hence, anchoring the Rupee, if it has the ability to do so, is beneficial and stems the need to raise rates aggressively.
Indeed, tolerating some currency depreciation is part and parcel of allowing global factors to be priced into India’s macroeconomic scenario, but a loss in the stability of the Rupee could complicate RBI’s inflation battle, which is aimed to bring inflation down while sacrificing as little growth as possible since the country is still emerging from the pandemic.
Opportunity In Adversity
However, if the RBI has to defend the Rupee using interest rates, it could result in inadvertent collateral damage, with no guarantees that it would necessarily work. Indeed, in our view, what worked in 2013 in stabilising the Rupee was not just weakening demand due to monetary tightening and import restrictions, but also the FCNR deposit scheme, which improved capital inflows and shifted the view on the balance of payments.
Following Winston Churchill’s famous adage of never letting a good crisis go to waste, the RBI could look to the measures undertaken now to further its longer-term reform agenda. While responding to the evolving external developments, there is also visible coordination between fiscal and monetary authorities. The government kick-started these with a series of changes in customs duties and the imposition of a tax on petroleum products. The RBI followed up by liberalising the regulations for FCNR(B) and NRE deposits and enhancing limits for foreign portfolio investments in government and corporate debt. The second set of measures was aimed at facilitating the international settlement of Rupee transactions. The move to allow international transactions in the Rupee, though unlikely to lead to any immediate material rewards, should go a long way in improving the acceptability of the Rupee, especially within our immediate neighbourhood.
With geopolitical tensions not likely to subside in the near term, the widening of the current account deficit might prove to be sticky, and policymakers must be prepared to take the necessary measures in the coming weeks and months.
What Remains In The Toolkit
The RBI might contemplate a special swap window for oil marketing companies and defence purchases, which could take away chunky sources of dollar demand from the currency markets. Since the government remains wary of taking currency risks on board via sovereign dollar bond issuances, it could encourage PSU banks to borrow in dollars to help to manage short-term dollar mismatches in the domestic market. Finally, if push comes to shove, the RBI could activate the special swap facility with the U.S. Federal Reserve by pledging its huge investments in U.S. Treasury bills.
We still believe India is far away from needing to garner FCNR(B) deposits, which are likely to be costlier now, given higher interest rates in advanced economies.
Moreover, there are early signs of moderation in the prices of international commodities, which could provide some relief to domestic inflation.
Monetary Policy Trajectory
Despite the Rupee’s depreciation, we continue to expect the RBI to raise policy rates by 35 basis points in the August MPC meeting. That is likely to be followed by two 25 bps rate hikes—one in September and another in December—which would take the repo rate to 5.75%, and which would also be the terminal rate in the current cycle. As recession fears intensify across developed economies, the RBI would want to remain nimble in ensuring the external as well as internal values of the Rupee are protected, even as it extends support to stabilise growth and let recovery take hold over the coming year.
Rahul Bajoria is Managing Director and Chief India Economist at Barclays. Views expressed are personal.
The views expressed here are those of the author and do not necessarily represent the views of BQ Prime or its editorial team.