Rupee on autopilot? RBI considers hands-off approach to manage currency
What's the story
The Reserve Bank of India (RBI) is mulling a change in its currency intervention strategy, The Economic Times reported citing market insiders.
The central bank may let the rupee depreciate in line with other emerging market currencies, to keep exports competitive and reduce the adverse impact of its US dollar sales on domestic liquidity.
The shift comes as importers rush to hedge their exposure while exporters keep positions open, expecting further depreciation. Today, rupee hit an all-time low of 86.27/USD.
Depreciation forecast
Rupee could slide by 2.5% against US dollar
The rupee is expected to depreciate by as much as 2.5% against the US dollar in the coming months, possibly falling to as low as ₹88.
This prediction is based on the overall rally in the Greenback picking up pace with rising yields in the US and reduced expectations of further interest rate cuts by the Federal Reserve.
Reportedly, the RBI has spent nearly $100 billion intervening in both spot and non-deliverable forwards markets, to stabilize currency fluctuations.
Intervention consequences
RBI's interventions impact domestic liquidity and growth
Sonal Varma, an economist at Nomura Securities, warned that excessive foreign exchange (FX) intervention could work if currency pressures are temporary.
However, she cautioned that persistent FX reserves depletion could make currencies vulnerable to speculative attacks.
"Heavy unsterilized USD selling can also tighten domestic liquidity and worsen growth prospects," Varma added.
The RBI's interventions have reportedly led to tighter banking system liquidity and reduced export competitiveness, while also encouraging speculative activity among traders and hedge funds.
Economic effects
Rupee depreciation's impact on inflation and growth
Anubhuti Sahay, head of India economic research at Standard Chartered Bank, noted that expectations of further rupee depreciation prompt importers to hedge more and exporters to supply fewer US dollars.
"This mismatch could have been avoided if the rupee had been slightly weaker and closer to the fair exchange rate," Sahay said.
According to RBI estimates in the Monetary Policy Report, 5% rupee depreciation would push up headline inflation by 35 basis points and growth by 25 basis points.
Market impact
Rupee overvaluation and system liquidity deficit
A treasury head at a foreign bank said the effect on core inflation wouldn't be that bad, with inflation rising by about 10-20 bps.
"On the flip side, our loss of competitiveness on the export front would not have been so dire," they added.
The banker also said had RBI allowed more rupee depreciation, currency overvaluation in terms of real effective exchange rate (REER) would be much less.
Due to forex interventions, banking system liquidity has slipped into deficit.