RBI intervenes to lift the sinking rupee at any cost

The Indian Rupee has been one of the worst performers in Emerging Markets over the last six weeks, as investors brace for a capital flight as the Federal Reserve threatens to cut bond purchases, but the central bank is unlikely to intervene to stop the currency's drop.



The currency has lost 3.3 percent against the US dollar since the beginning of December, raising fears of a faster depreciation and central bank intervention. However, experts say the currency should be allowed to decline in order to remain competitive in global markets.
As a strengthening economy and worldwide shortages are projected to exert further pressure on the current account, rising crude oil prices and a record current account deficit (the excess of imports over exports) in September are also playing out in the currency market. "The recent Rupee decline versus the USD is due to increased global crude oil prices, supply chain disruption, and a stronger dollar index," said Bhaskar Panda, Executive Vice President of HDFC Bank. "We haven't seen any Central Bank activity recently. The rupee is still expensive in comparison to other Asian currencies, thus it will likely lose value in the medium run."



The rupee has lost 1.5 percent against the dollar this month, making it the second worst performing Asian currency. The dollar increased 0.19 percent to $75.37 per dollar. The Rupee has started to weaken in recent weeks after a stable performance. While many expect the RBI to interfere, the central bank may not, as it considers factors other than the US dollar exchange rate. Because the rupee has risen against other currencies this year, the RBI may allow it to decline in order to maintain competitiveness.

"Until a few weeks ago, the Rupee was comparatively overpriced, and volatility was close to multi-year lows," stated IFA Global, a currency consultancy business. "As a result, the RBI appears prepared to let the overvaluation correct itself rather than interfere too aggressively by selling Dollars."
According to RBI data, the Rupee's Real Effective Exchange Rate increased by 1.3 percent against a basket of 40 currencies from January to September. It is up 1.5 percent in the six-currency REER basket. REER is a currency's weighted average against a basket of major currencies. A rise means exports are becoming more expensive, and vice versa. With $637 billion in foreign exchange reserves, India's central bank has the ability to act to smooth out market volatility if a global shock causes capital flight.

However, any devaluation caused by outflows could be temporary, as a wave of high-profile Initial Public Offerings, including Paytm's, are slated to enter the market in the coming months. Economists predict that these deals might generate $30 to $40 billion in inflows, providing currency support. "For the central bank, the dilemma of plenty is nothing new. The local currency would most likely fall, but foreign inflows will likely prevent a sharp drop in the rupee's value, obviating the need for currency market intervention." CARE Ratings economist Madan Sabnavis said.

Also Read : How is interest accrued on PF taxed?