RBI measures unlikely to open forex floodgates, may not stop rupee slide: Experts

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The Reserve Bank of India (RBI) measures to boost foreign exchange inflows may not lead to a huge influx of foreign capital into the country and there is unlikely to be a telling upward impact on the exchange rate, experts and economists told Moneycontrol.

“We have seen such ad-hoc measures in past episodes of rupee depreciation as well with little impact,” said Vikas Bajaj, head of currency derivatives at Kotak Securities. “We have to accept the fact that the rupee is facing problems on both the current (rising trade deficit) and capital account (outflows) side in a backdrop where the external environment for the dollar is quite supportive and financial conditions are getting tighter.”

When the external environment is hostile, Bajaj said, the RBI’s measures might have a salutary effect on the rupee in the short term. However, they may not change the broad direction of the rupee, which depreciated beyond 80 to a dollar on July 19.

The RBI announced a series of measures earlier this month to boost forex inflows and alleviate pressure on the rupee’s exchange rate. These included greater freedom to banks to raise foreign currency deposits from non-residents and lifting of a cap on foreign portfolio investors’ short-term investments in government and corporate debt.

Also read: RBI widens way for inflow of foreign funds to stem rupee slide, says official

FX troubles

The central bank’s decisions come in the wake of the rupee hitting successive record lows over the past few sessions. The rupee hit a record low of 79.36 per dollar on July 5, Bloomberg data showed. The Indian currency has weakened by 4.5 percent against the dollar so far in FY23 amid global recession risks, high risk aversion, and large policy spill-overs.

All this while, the RBI has looked to use its foreign exchange reserves – which it said were “adequate” – to prevent exchange rate volatility. Traders estimate the RBI sold $30 billion-40 billion in the spot and forward markets over the past six weeks.

The RBI’s forex reserves stood at $593.32 billion on June 24, down from $632.95 billion on February 18. Russia invaded Ukraine on February 24.

Additionally, the central bank’s forward book was net long $63.83 billion as of April 30, providing even more buffer.

More than adding to the substantial FX reserves, market participants see the RBI’s measures as a signal of its intent to end the rupee’s runaway depreciation and preserve foreign exchange reserves. Moreover, the central bank is seen wanting to prevent speculative attacks on the rupee and provide directional signals. The steps could also help address the current dollar shortage in the spot market to some extent, they said.

“These measures are important from a sentiment perspective,” said Abhishek Goenka, founder of IFA Global. “It conveys to market participants that the RBI is committed to preventing runaway depreciation of the rupee and containing volatility.”

Minor boost

What the measures are unlikely to do is materially boost inflows.

“The measures are proactive when seen in the light of 2013, albeit less effective in incentivising flows,” said Madhavi Arora, lead economist at Emkay Global Financial Services.

In 2013, the taper tantrums caused by the unexpected and potential tightening of US monetary policy led to a precipitous fall in the rupee to a then record low of 68.80 per dollar. In response, newly appointed RBI governor Raghuram Rajan announced measures in September 2013 to bolster forex reserves and stabilise the rupee. These measures garnered $34 billion.

However, the July 6 measures are not as powerful as the 2013 ones, when the RBI bore the risk in a swap scheme for banks. This made mobilisation of leveraged Foreign Currency Non-Resident (Bank) deposits highly lucrative, said Emkay’s Arora.

“We are unlikely to see the same zeal this time around,” she added, with the RBI only removing the interest rate cap on these deposits and excluding incremental deposits from the computation of Net Demand and Time Liabilities for the maintenance of Cash Reserve Ratio and Statutory Liquidity Ratio.

Forex market experts agreed with Arora’s view.

“I’m not expecting massive inflows,” said Kunal Sodhani, assistant vice president, global trading centre, at Shinhan Bank India. “The cost of hedging exposure could be an impediment, given hardening forward premia in overseas markets.”

HDFC Bank’s current one-year USD FCNR deposit rate is 3.35 percent and the one-year hedging cost is 3 percent, explained IFA Global’s Goenka. On a fully-hedged basis, the cost of this deposit is 6.35 percent, which is at par with one-year certificate of deposit rates. Therefore, there is not much scope for banks to hike deposit rates further to attract more FCNR deposits, he added.

According to Gaura Sen Gupta, India economist at IDFC FIRST Bank, this measure could enable banks to increase interest rates by 25-to-30 basis points on FCNR deposits.

“We may not see as much interest as we saw in 2013,” added Goenka. “We may see incremental flows of about $4 billion to $5 billion.”

Exchange rate impact

Even if the measures turn out to be more favourable than expected, the central bank will most likely absorb dollars in the spot market to prevent a rapid appreciation of the rupee, in keeping with its stance of discouraging sharp exchange rate movements.

Traders said the trend of a weaker rupee aligns it with the current fiscal health and other domestic economic indicators. The RBI may not want to derail this alignment, said traders.

As per latest RBI data, the rupee’s real effective exchange rate in May against a basket of 40 other currencies on a trade-weighted basis was 104.90. A real effective exchange rate of more than 100 indicates the rupee is overvalued.

The market’s assessment of the efficacy of the RBI’s steps was reflected in the rupee’s exchange rate on July 7, with the currency closing just 12 paise higher at 79.18 per dollar as per Bloomberg data.

According to experts, the RBI’s measures could take some time to affect the exchange rate as pressure on the local unit comes primarily from the large – and sticky – current account deficit.

“The measures announced will work more as enablers, while actual flows will be a function of global risk sentiment,” said IDFC FIRST Bank’s Sen Gupta. “The measures could result in a rise in forward premium by increasing the supply of dollars. However, a lot will depend on how global risk sentiment evolves.”

An elevated current account deficit on the back of a high import bill due to increased global commodity prices will be a drag on the rupee. The US Federal Reserve’s aggressive rate hike trajectory will also keep the dollar well-bid, said experts.

“The Fed is on track to deliver a 75-bps rate hike in its July policy, which does not bode well for the rupee,” said Swati Arora, an economist at HDFC Bank. “Besides, persistent FPI outflows, especially from the equity side, are likely to continue to weigh on the rupee. Furthermore, weak risk sentiment amid rising recession fears is also likely to keep the rupee under pressure.”

The Fed is scheduled to meet on July 26-27. Arora expects the rupee to fall to 79.50-80.50 by September.

What next?

Money market participants said the RBI may have to announce more steps in the coming days, specifically to keep rupee short sellers at bay and prevent speculative attacks on the currency. Otherwise, the rupee will likely remain under pressure.

“The RBI could possibly introduce a swap window like they did in 2013, which will give more incentive to banks to get in more foreign deposits,” said Soumyajit Niyogi, director, core analytical group, India Ratings & Research. “Given the falling forex reserves and falling domestic banking system liquidity, these are necessary.”

Societe Generale’s India economist Kunal Kundu said the RBI would need to be “aggressive” with its subsequent policy rate hikes as a more effective tool against capital flight.

The RBI’s Monetary Policy Committee is set to meet on August 2-4.