Barely two months ago, Reserve Bank of India (RBI) Governor Shaktikanta Das reminded the forex market that it has a strong enough umbrella of reserves to protect the rupee, and that it would not hesitate to use it.
But umbrellas tend to get buffeted or turn inside out in the face of strong winds, and the dollar’s relentless rise to multi-year highs has been building up into a gale. The dollar index has surged more than 16 percent this year, with much of the rise coming in the past three-four months, as the US Federal Reserve began its large rate hikes.
The RBI is thus encountering two vexing problems — depleting forex reserves and tightening rupee liquidity — that have slowed down its intervention, while its Asian peers are just upping their game in the market. For instance, the Bank of Japan has stepped in to intervene for the first time in decades to defend the yen.
For the Indian rupee, the results are visible already as the currency hit a fresh low by weakening beyond 80 to a dollar. The Indian unit’s relative resilience versus its Asian peers could now change. Offshore non-deliverable forward rates are already predicting a fall to 81.70 per dollar in the next three months.
According to currency dealers, the resolve of the RBI to protect the rupee was strong at the 80-to-a-dollar level. Indeed, despite most Asian units weakening sharply in July and August, the rupee showed resilience, even appreciating briefly in August. However, the Fed’s latest dot plots, which were more hawkish than anticipated, have now turned the tide decisively against the rupee.
This onslaught comes at a time when the RBI has already spent more than a tenth of its forex reserves in defending the currency. It has sold $40 billion, half of which it did in just one month, July. Since the reserves are down by a massive $56 billion so far in FY23, economists are fretting about their adequacy levels. The import cover, one measure of reserve adequacy, is now down to 9 months from a high of 15 months a year ago.
Anubhuti Sahay, senior economist at Standard Chartered Bank, told Moneycontrol earlier this month that the RBI will need to slow down its intervention lest it depletes its firepower completely.
With its reserves depleted, India’s import bill is unlikely to come down significantly this year. Granted, oil imports are cheaper with the global crude price easing off and discounted imports from Russia helping. Even so, economists estimate that India will need to find roughly $30 billion to bridge its trade deficit every month. Sourcing these dollars will get tougher, notwithstanding the long-term bullish narrative for Indian markets.
“Capital inflows, while returning, are unlikely to be enough to meet funding requirements, which points to the BoP being negative for FY22-23. Even potential global bond-index inclusion is only likely to result in inflows 6-9 months further out, and is unlikely to be a source of help in the short term,” economists at Barclays said in a September 22 note. In short, the central bank has a tough call to make between continuously depleting its reserves or letting the rupee erode.
A fallout of the RBI’s intervention is the tightening of rupee liquidity. As the central bank sells dollars, it sucks out rupees from the domestic banking system. This explains the emerging deficit in liquidity after a gap of more than three years.
While the liquidity deficit helps the central bank in reining in inflationary expectations as short-term rates go up, it will need to maintain a balance here.The drain in liquidity coincides with the comeback of credit growth. As the private sector readies to raise its bank borrowings for investment, the RBI will need to ensure that those needs are met at a reasonable price. This will stymie its intervention efforts.