‘The rupee will slip even further to 77-78... and would have fallen to 80 without RBI intervention’: Deutsche Bank’s Mayank Khemka

Mayank Khemka, MD and CIO of Deutsche Bank, says the big story in India is the rise of the domestic investor. (Illustration: Suneesh Kalarickal)

The Reserve Bank of India (RBI) has sold a significant amount of dollars–in the spot market and with sell/buy swaps–over the last six months. Its forex reserves have fallen from $642 billion (October 29, 2021) to $603 billion (April 15, 2022), and the central bank auctioned $5-billion USD/INR swap (selling dollars and buying rupees) in the forwards market on March 8, and will auction another $5-billion USD/INR sell/buy swap on April 26. Why? 

Mayank Khemka, Managing Director and Chief Investment Officer at Deutsche Bank, in a conversation with Moneycontrol helps decode it. 

Why is the RBI selling a lot of dollars in the forwards markets?

One is that the rupee has been weak, like other currencies such as the British pound and yen, because the dollar has been strong… if you look at the dollar index, it has been above 100. The rupee will slip even further to 77-78, like I said in my report (titled India:adverse macro variables point to INR weakness) and would have fallen to 80 without RBI’s intervention. The central bank’s forex reserves have fallen by $40 billion over the last six months. It was $642 billion till September - October 2021 and it has now come down to $600 billion. Though not all of it has gone to support the rupee, or manage the volatility in the forex market, at least $20-25 billion would have gone towards that. Second and the bigger reason is to manage liquidity. During the pandemic, the RBI like other central banks supported the economy and let the monetary policy become very loose. It was buying dollars and our reserves went up by $100 billion, but this releases rupee into the system. All of this led to excess liquidity in the system and the yield curve has become very, very steep. Overnight rates as of now are 3.75% while 10-year G-Sec is 7.1% or 7.2%. The difference is nearly 300 bps when it has been historically 150 bps. Now, to support the rupee, reduce the liquidity and reduce volatility in the forex market, they are selling dollars and buying rupees. 

Also read: Liquidity withdrawal will be done over many years: RBI Guv

Isn’t it riskier to buy dollars in the forwards market than in the spot market?

There is no risk. They are just buying $10-billion (in currency swaps) with a reserve of $600 billion. That is barely 2% of the reserves. India’s forex reserves are the fourth highest in the world today.

FPIs have been selling heavily…

Yes, massively.

Do you see this selling accelerate?

Considering they have sold almost $7-8 billion every month for the past few months, I don’t know how much more they can sell. 

This is largely a deleveraging theme that is unfolding. Earlier the borrowing rates were zero, the FPIs were getting money at maybe one or one-and-a-half per cent and the FPIs were deploying it wherever they saw an opportunity, whether it was commodities or in emerging markets. The Fed indicated rate hikes only in December but you see the selling started in November because obviously markets got a whiff of it (the rate hike) (and the deleveraging began). The Fed finally raised the rates in March. 

Of course, India gave them excellent gains also. So they are booking profits also. But largely, it is deleveraging that is happening.

On whether this selling will accelerate… I can’t predict because there are too many variables. The selling will definitely end before the last rate hike. But it (the trend) is impossible to predict for the next two to three months. 

India looks particularly unattractive because of the weakness in its currency. Do you think the markets here are at greater risk than other emerging markets?

Talking from a purely fund flows angle… So the big story in India has been the rise of the domestic investor. In my entire career of 25 years, this is the first time I am seeing such heavy FPI selling and the market remaining where it is. It is a huge surprise and a pleasant surprise. We have been talking about this for years, that the Indian savings should enter the equity markets and that is finally happening. Otherwise the money used to go into fixed deposits, gold and real estate (largely). This large amount of domestic money finding its way into the equity market has more or less negated the entire FPI selling. The SIP book itself, for mutual funds, is now Rs 11,000-12,000 crore a month. This SIP book looks resilient also because it is made up of small monthly amounts of Rs 5,000 or Rs 10,000 or even Rs 50,000. This kind of FPI selling absorption (by domestic investors) is a huge story. Without this (the buying by domestic investors), five years ago, this market would have been 30% lower than it is now. 

How will inflation affect this trend?

I’d like to stress on real interest rates here. Real interest rates would mean interest rate minus inflation, and that is negative today. If you put in an FD that gives you 5% return and inflation is at 6.9% (March CPI), then your return is essentially in the negative of -1.9%. You are actually losing money. Equity is probably the only asset class that will continue to beat inflation in the long term. Therefore, as long as the real interest rates remain negative, Indian equities will continue to see inflows from domestic investors.