Will RBI's Intervention Stem The Rupee's Fall, Dollar Shortages?

The RBI's measures could help bring some relief, albeit over time, to the forex markets in an increasingly adverse global scenario, economists said in response to a series of steps announced by the central bank.

These steps include liberalising limits and interest rate caps for external borrowings, and are intended to stem the rupee's fall and address dollar shortages faced in recent days.

The Indian rupee fell to a record low of 79.37 against the greenback on Wednesday, before erasing some losses and closing at 79.30. The rupee, the RBI said, has dropped 4.1% so far this fiscal year, which is lesser than the depreciation seen across some other emerging and developed market currencies.

From the start of the year, it has dropped 6.26%, according to Bloomberg.

After actively drawing down forex reserves to curb volatility in the rupee, the RBI has doubled down on its effort by introducing macro-prudential steps as the next line of currency defence, Vivek Kumar, economist at QuantEco Research, said.

The temporary measures announced by the central bank to encourage FPI debt investment, NRI deposits, dollar funding by banks, and corporate ECBs should bring in some modicum of stability as they would help in narrowing the extent of balance of payments deficit in FY23, he added.

"This should soften the negative spillover impact from adverse global factors like a strong dollar, heightened geopolitical uncertainty, and still somewhat elevated commodity prices, especially crude oil."

While RBI's announcements are a positive from the perspective of foreign flows, it may not change the direction of the currency, said Indranil Pan, chief economist at Yes Bank. While the fair price model points to the rupee weakening to 81/$ by March 2023, it could now stop short at 80 maybe, he said.

Global interest rates are expected to rise and emerging economies are not as well placed as they were, even a few months ago, according to Pan. That said, the future trajectory of the rupee will depend on evolving macroeconomic conditions and crude oil prices. "For instance, the outlook will change if crude was to fall to $80 per barrel instead," said Pan.

Aurodeep Nandi, India economist at Nomura, said that while it is interesting that the RBI is rummaging through its policy arsenal in the wake of the recent rupee depreciation, measures like easing regulations around foreign flows and relaxing ECB norms typically form the first line of defence against currency tantrums.

"These measures are time-bound, and while they might have some impact at the margin, it is important to note that there are other broader drivers of external sector weakness," said Nandi. These drivers include a sharp rise in current account deficit–which Nomura projects at 3.3% of GDP for FY23–and aggressive tightening by the U.S. Federal Reserve.

The measures announced by the RBI today is likely to boost short term inflows which may bring the local unit again in the positive territory, Heena Naik, research analyst for currency at Angel One said. The RBI has allowed FPIs to invest in short term debt securities which may attract huge money into the system and even allowed banks to borrow more overseas while giving more incentives to corporates to borrow more via ECB route, she said. In conclusion, the measures undertaken by the RBI shall push the Indian Rupee towards 77.00 levels, according to Naik. The appreciating trend in Rupee is likely to be temporary since the global uncertainty still looms over the markets, she said. After that, the USDINR shall again bounce back to 79.70 levels.

The RBI’s measures comes on the back of substantial dollar shortage and are aimed at shoring up the capital flows into India, Suvodeep Rakshit, senior economist, Kotak Institutional Equities said.

While it is difficult to ascertain the quantum of flows, the measures are attractive the for banks and FPIs, according to Rakshit. "While India’s macro situation is better than in the 2013 period, these measures would alleviate and preempt the adverse impact on the external sector balance, he said, adding that the RBI is clearly aiming at softening the depreciation bias and capping the speculative moves against the rupee."

The measures follow government action last week to reduce the current account deficit by raising import duties on gold and oil exports, Rahul Bajoria, chief economist at Barclays, said. The RBI's measures represent a coordinated effort to manage currency weakness, and mark a material relaxation of regulation related to debt capital inflows to the economy that should over time lead to greater inflows, according to Bajoria.

"We believe the RBI's measures are comprehensive but will take time to impact the foreign currency demand-supply imbalance."

The RBI has taken sound and proactive steps to prevent runaway rupee depreciation, Ritesh Bhansali, vice president at Mecklai Financial Services, said. This will bring in dollar liquidity through FCNR deposits, FPI flows into the debt segment and banks raising overseas borrowing, he added.

The measures will work as a medium-term positive not only from a dollar supply perspective, but also from a sentiment perspective, said Bhansali, adding that the central bank's actions show willingness and commitment to walk the talk in controlling excessive rupee depreciation.

In 2013 when former RBI Governor Raghuram Rajan brought in an FCNR scheme, the rupee gained and India saw good flows, Anil Kumar Bhansali, head of treasury, Finrex Treasury Advisors, said. "Considering that, we may see inflows this time as well but current circumstances are different with a war on and oil prices at $103 a barrel," he cautioned.

"While the current steps may not be enough to stop the runaway depreciation we are seeing, we may see more steps from the RB and the government," said Bhansali.

The dollar index is at its strongest in about 20 years; therefore, the current weakness in the rupee may persist, he added. "Possibly the steps have been taken to avoid the rupee touching 80 for the moment."