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Informist, Monday, Jul 29, 2024

 

NEW DELHI – The Reserve Bank of India is unlikely to change its strategy of intervention in the foreign exchange market in the near term and keep the real exchange rate stable by increasing forex reserves and keeping the rupee competitive, Morgan Stanley said in a report on Sunday.

 

"Higher reserves could serve India well, reducing its external vulnerability. They keep INR (Indian rupee) competitive to support exports while lowering the private sector's cost of capital. Killing three birds with one stone, the RBI is unlikely to change course in the near term," it said. Morgan Stanley expects the RBI to continue its firm grip on the currency.

 

The report noted that despite an improving balance of payments, the rupee has not seen much appreciation owing to the RBI's active intervention. Further, it said that the rupee's recent weakness raises concerns about whether the RBI would tolerate more weakness in the currency. The RBI may like the rupee to be a bit weak in nominal terms to keep the Indian currency competitive, it said. The Indian rupee has depreciated 0.4% against the dollar so far this month. The rupee fell to a record low of 83.7375 a dollar today. 

 

Morgan Stanley expects India's balance of payments to improve in the next 6-12 months, which would provide a strong backdrop for the Indian currency. However, whether the Indian unit will appreciate on account of this depends on the RBI's management, it said.  

 

India's current account was in a surplus of $5.7 bln in Jan-Mar, a recovery from a deficit of $1.3 bln recorded a year ago. Morgan Stanley expects India's capital account balance to track in a steady range of 2.7-3.0% of GDP in the next 10 years. 

 

"The RBI should continue to lean against the improving balance of payments and increase its FX reserves, which reduces India's vulnerability to external shocks," the report said. India's foreign exchange reserves hit an all-time high of $670.86 bln as of Jul 19. 

 

Foreign fund inflows into the Indian domestic market are expected to continue as the US Federal Reserve is expected to cut rates in the next few months and as China's growth continues to surprise on the downside, it said. On the fixed income side, inflows for the next six to 12 months should be robust on the back of Indian government bonds' inclusion in JP Morgan's Government Bond Index – Emerging Markets. "The market already saw $10 bln of inflows last December, and we expect more than $20 bln of inflows before 1Q25 (Jan-Mar)," it said.

 

The report said that post the inclusion of Indian gilts into the JP Morgan index, the RBI has been neutralising the impact of foreign inflows on the currency through sell/buy swap operations in the forward market, which has led to a jump in dollar/rupee forward premia. "Such an approach by the RBI should continue in the future," it said. Premium on the one-year dollar/rupee forward contract rose to a near six-month high of 1.83% today. 

 

Assuming the US dollar to be flat for next 10 years, the dollar/rupee could be in the range of 93 to 98 a dollar by 2035. That is, a gradual annual depreciation of 1.0-1.5%. The report expects the RBI to keep the rupee's real effective exchange rate largely flat in the medium-to-long term.  

 

Further, the report said that more internationalisation of the Indian rupee is required for the local unit to join the Special Drawing Rights, or SDR, basket so that the rupee could be used more in trade settlement and capital markets. "We see 2032 being the more likely time for India to join (SDR) but the IMF could bring the schedule forward should policymakers make good progress," it said.

 

SDRs are a supplementary international reserve asset created by the International Monetary Fund in 1969. As an interest-bearing reserve asset, SDRs are allocated by the IMF to its members in proportion to their standing in the organisation, largely based on their share of the global economy. SDRs can be exchanged through volunteer trading arrangements with other IMF member countries.

 

The Executive Board of the IMF typically reviews the SDR basket every five years. The next review will happen in 2027. Currently, the basket comprises the Chinese yuan, the US dollar, the euro, the Japanese yen and the pound sterling. 

 

"Inclusion of INR (Indian rupee) in the SDR basket would improve foreign exchange risk management as it would enhance confidence in the country's currency and domestically oriented monetary policies, increasing its credibility among foreign investors and deepening financial markets," according to Morgan Stanley. "It would also lower transaction costs for cross-border trade and investment operators." 

 

Further, Morgan Stanley expects India's export market share to rise to 4.7% by 2033 from 2.5% in 2023, reflecting a broad-based increase in export market share for both goods and services.  End

 

US$1 = 83.73 rupees

 

Reported by Pratiksha

Edited by Akul Nishant Akhoury

 

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