RBI may need to tweak its forex strategy, allow rupee to weaken: Experts

RBI may need to tweak its forex strategy, allow rupee to weaken: Experts

Since the past few days, the rupee has hit a series of record lows and is currently around 79 against the US dollar as concerns over economi

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Since the past few days, the rupee has hit a series of record lows and is currently around 79 against the US dollar as concerns over economic growth amidst multi-year high inflation, interest rate hikes, persistent foreign funds outflow, high crude oil prices, and volatile domestic equities weigh on sentiments. 

The weakening of rupee has been accelerating since last month with global markets witnessing massive bearish tone amidst fears of recession due to macroeconomic risks. US Fed took an aggressive approach towards increasing key interest rates to tame inflation that strengthened the greenback against a basket of currencies including rupee. More rate hikes are expected not just from the US Fed but other major central banks as well. 

At the interbank forex market on Wednesday, the Indian rupee closed at its all-time low of 79.04 per dollar down by 19 paise.

As per the experts at Reuters, to control the weakening of the rupee, RBI has sold dollars in the spot market and simultaneously bought and sold in the forwards market.

Traders told the news agency that RBI’s actions in the onshore forwards market have led premiums to crash sharply with the 1-year annualised forward premium now below 3%, levels are last seen in November 2011, wiping out carry trade gains and pressuring the spot rupee price lower.

Radhika Rao, a senior economist with DBS Bank in the Reuters report said, “Maturing forward contracts are suspected to be weighing on the currency this week, besides an unsupportive macro backdrop of portfolio outflows, high oil and bid dollar.”

Notably, these technical conditions have made forward market intervention a less-than-ideal tool for controlling volatility in the rupee and have resulted in fewer options for RBI to reduce the risks of capital flight.

The central bank could make greater use of spot market intervention – which would run down central bank reserves – or may just opt to let the rupee weaken according to macroeconomic fundamentals, the report said.

Rao said, in the short-term, the intervention strategy might return to the spot to meet dollar demand, in light of a sharp fall in forwarding premiums.

Meanwhile, Madhavi Arora, senior economist at Emkay Global said, falling FX reserves, persistently high commodity prices, limited exchange rate pass-through to inflation and elevated INR valuations will likely tilt the balance towards a less interventionist FX policy in the coming months, Reuters cited.

India’s foreign exchange (forex) reserves dipped for the third consecutive week to $590.588 billion as of June 17, 2022. Foreign currency assets declined to $526.882 billion, while gold reserves slipped to $40.584 billion, as per RBI’s weekly data.

Arora added that allowing INR to gently weaken over time is the right strategy, giving CAD space to improve.

In its note, QuantEco Research said that they expect INR could weaken towards 81 to a dollar before the end of FY23.

Going forward, Jigar Trivedi – Research Analyst- Commodities & Currencies Fundamental, Anand Rathi Shares & Stock Brokers said, “we expect the Rupee spot to depreciate towards 80/81 levels by the year-end as twin deficits add to pressure on the emerging market currency. The Fed is expected to hike rates by 75 bps in the July meeting, while the RBI meeting is not due until August, which could narrow the yield differentials between India and US, and might further weigh down on Rupee.”

In its monetary policy statement earlier this month, RBI governor Shaktikanta Das said, “Several EME currencies have thus faced depreciation pressures. Safe-haven demand for the US dollar has increased. Amidst all these, the Indian Rupee has moved in an orderly fashion and has depreciated by 2.5% against the US dollar during the current financial year so far – faring much better than many of its EME peers.”

The monetary policy was announced on June 8 and since then rupee has depreciated furthermore.

Last month, Das had said that the rupee was market-determined, but the RBI would not allow “runaway depreciation” in the currency.

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