Rupee gains give RBI window to top up FX reserves but big build-up unlikely, says Shinhan Bank’s Kunal Sodhani

Kunal Sodhani, Head of Treasury, Shinhan Bank

• Rupee saw its biggest single-day gain since 2018 after US-India trade deal news
• RBI may gradually raise forex reserves to $720-725 billion, not aggressively
• Rupee may range 89.20-92.20 by March; flows to remain volatile.

Did our AI summary help?

The gains in the rupee following the India-US trade deal announcement have opened a tactical window for the Reserve Bank of India (RBI) to add to its already robust foreign exchange reserves but any aggressive build-up looks unlikely, Kunal Sodhani, Head of Treasury at Shinhan Bank, said in an interview to Moneycontrol.

On February 3, the rupee recorded its biggest single-day gain since mid-December 2018 after Prime Minister Narendra Modi and United States President Donald Trump's late-night annoucements  ignited investor optimism and spurred foreign inflows. The rupee gained 1.4 percent to touch 90.22 against the dollar.

With India’s FX reserves already at an all-time high of around $709 billion and providing close to 11 months of import cover, Sodhani said the central bank may use sustained inflows to nudge the reserves towards the $720-725 billion zone as a buffer against geopolitical risks and unforeseen shocks rather than chasing a significantly higher stockpile. Edited excerpts of the interview:

After the announcement of the US-India trade deal, the dynamics of the currency market seem to have changed. The rupee has appreciated around 1.4 percent, the highest since December 2018. How do you see this shift and what does it mean for the currency in the near and long term?

So, first of all, I think the sentiment-driven demand for the rupee has obviously strengthened because foreign investors will reassess their risk and they will consider India as a destination to invest. Secondly, if we talk about the lower tariffs, which will make India’s exports more competitive in the US, potentially, it will narrow the current account deficit over time, which is a structural positive for the currency.

And third, the tariff cut gives India a relative export advantage compared with many Asian competitors such as Vietnam, Bangladesh, Pakistan, who face similar or higher US tariffs. So overall, it remains a positive sentiment.

But there are a few concerns from my side which can act as a headwind. If we actually read the tweets from both sides, from Trump as well as India, Trump has been very clear that there will be some kind of bilateral trade business to the tune of $500 billion.

My concern here is, first, there is no communication from our Prime Minister over it. Second, there are no nitty-gritties on how this $500 billion will be placed and what would be the outcome. Third, if I even draw the numbers, India’s exports to the US are around $85 billion annually, while imports from the US are around $45 billion annually. So, taking that into cue, I don’t know where this $500 billion of trade comes from, how it will impact, or whether it will actually take place or not. So, I would rather wait for more clarity instead of jumping the gun that it is purely positive.

And second, about Russian oil imports, we have not commented anything on that yet. We have only commented that tariffs have been lowered from 25 percent to 18 percent. So these two concerns prevail for me at this point in time.

So, are you saying this is more of an initial rally, with concerns likely to emerge later for the currency market?

Correct. Till the point we don’t have clarity, knee-jerk sentimental optimism will prevail, which is what we saw today. But for a sustainable appreciation or sustainable flows into equity markets, we will have to wait and watch for more clarity.

Given this appreciation, do you think the RBI will use the opportunity to build forex reserves further, especially when reserves are already around $700 billion?

At the current juncture, we are standing at around $709 billion of FX reserves, which is an all-time high. Even during periods of depreciation, we have seen appreciation in FX reserves at large.

Whenever flows are positive and if they are sustainable, the RBI can absorb those flows and create more FX reserves to build a cushion. Currently, we have around 11 months of import cover, which itself is very good. So I don’t think much more ammunition is required but geopolitical uncertainties or unforeseen events can always come up. So, the RBI may want to grow reserves towards maybe $720-725 billion.

If reserves move towards $725-730 billion, will that growth be driven more by foreign currency assets (FCAs) or gold?

It is very difficult to comment but it has to be a mix. It cannot be purely gold. Revaluation will also happen, and considering the drop in gold prices, revaluation may take the overall number lower on a week-on-week basis.

But overall, central banks will continue to have gold in their kitty. FCAs contribute around 85 percent of India’s FX reserves, which is a very large chunk, and I think that will prevail. I don’t think there will be any replacement, they will grow hand in hand.

What levels do you see for the rupee by the end of March, once the initial optimism fades and uncertainties resurface?

If I talk about dollar-rupee levels, March typically sees higher rupee demand due to corporate book closing, which provides some support to the rupee but that is just one part of the story; global cues also matter.

Overall, I see a broader band of 89.20 at the lower end, very optimistically, and 92.2 on the higher side. At this point, because of sentiment benefits, 92 looks far off and remains the most crucial resistance but 89.20–89.50 levels can be tested.

Will this optimism around the trade deal and the rupee’s appreciation drive sustained foreign flows, especially after recent equity and debt outflows?

Flows remain very crucial for a developing country like India, though FPIs are hot money. In January, we saw nearly $4 billion of outflows. I think flows may remain volatile. I do not expect any sharp inflows because uncertainty still prevails. One or two days of optimism have not changed the entire macro landscape. So flows may not turn extremely positive and volatility will continue.

The RBI has been active with swap auctions and the forward book in the three-year segment is building up. How concerning is this and does the current shift in currency markets ease that concern?

The RBI’s buy-sell swaps, like the $10 billion swap on February 4, are primarily to elongate the maturity profile of the forward book, pushing positions into one, two, three-year or longer segments rather than expanding overall liquidity. From that perspective, RBI has done a good job.

At the same time, they are focusing on other liquidity measures such as VRRs and OMOs. For July, we expect around $23.6 billion worth of rupee liquidity through VRRs, buy-sell swaps and OMOs. This should improve durable liquidity conditions and help stabilise short-term money market rates.

We should wait and watch how liquidity measures pan out. One-year annualised premiums should sustain around 2.6 percent to 2.8 percent.

Finally, what are your near-term and long-term projections for the rupee?

Over a longer horizon, say by December 2026, I believe 89.50 to 93 will be the broader range.