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Informist, Friday, Dec. 20, 2024

 

By Pratiksha

 

MUMBAI – The rupee's fall to 85 per dollar on Thursday made for a headline, but not a shocking one. The rupee may have weakened because of global events, but the swift pace of its recent fall has been an outcome of an inevitable development back home – a subtle shift in the Reserve Bank of India's intervention strategy, currency traders said.

 

Just 46 trading days after the rupee's first tryst with the 84-per-dollar mark, it fell past the psychologically crucial level of 85 per dollar on Thursday, taking no one by surprise. The latest fall came after the US Federal Open Market Committee meeting, where Fed officials scaled down their rate cut projections for 2025 to 50 basis points from 100 bps. But the main reason the rupee has fallen 0.7% in the last 14 trading days is that the RBI has allowed it to.

 

The central bank, which had prevented even moderate fluctuation in the exchange rate since last year, seems to have developed a tolerance for a depreciating rupee over the last few weeks. Case in point: Of the 2.3?preciation in the Indian currency this calendar year, more than 1% took place only since last month.

 

In fact, the rupee's march from the big figure of 84 a dollar to 85 happened in just over two months, while the move from 83 to 84 took almost two years. The reason most foreign exchange traders saw this coming is that the RBI's strategy of severely restricting the rupee's movement was increasingly proving to be unsustainable. It was burning a hole in the RBI's foreign exchange reserves, increasing the rupee's overvaluation, and hurting India's export competitiveness.

 

"Over the last month, the RBI has let the rupee move a bit, while continuing to spend its reserves. The current currency level is reducing the competitiveness of exports. Should the RBI choose to let the currency adjust, the buying pressure might lighten at higher levels," said Nitin Agarwal, head of trading at ANZ Bank India.

 

Over October and November, the RBI's persistent intervention strengthened the rupee 2.3% against the Chinese yuan. However, the central bank has allowed the rupee to nearly match the Chinese currency's pace of depreciation in December. With China widely expected to allow weakness in the yuan in 2025, the RBI's strong hold on the rupee would have only increased its overvaluation against currencies of India's trading partners, of which China is the most significant. The rupee's real effective exchange rate against a basket of 40 currencies, based on trade weights, was at a near seven-year high of 107.21 at the end of October, indicating overvaluation of around 7%.

 

As the RBI went all guns blazing to defend the rupee in recent months, it saw its foreign exchange reserves depleted by around $50 billion since early October. India's foreign exchange reserves were at an over five-month low of $654.86 billion as on Dec. 6. On top of that, the central bank's outstanding forward dollar sales have risen sharply to $49 billion at the end of October. This number is expected to have shot up further in November due to buy/sell swaps in the dollar/rupee forwards market and aggressive dollar sales in the offshore non-deliverable forwards market. The RBI's large outstanding forward sales have been putting downward pressure on forward premiums, reducing the cost of speculation against the rupee.

 

An overvalued rupee, low forward premia, and fast eroding reserves would be an invitation to speculators to bet against the Indian currency if the RBI continued with the intervention strategy it has been following for over a year. "The pressure on the rupee is quite strong and is likely to persist without the RBI revisiting its intervention strategy," Agarwal said.

 

It is not surprising that in the NDF market too, the RBI seems to have changed tack lately. Over the last two weeks, it has stopped rolling over its forward dollar sales. Instead, it has resorted to verbal intervention and told domestic banks to stop speculating against the rupee.

 

Amit Pabari, managing director at CR Forex, is of the view that the RBI appears constrained in its ability to intervene in the currency market as effectively as earlier this year, partly due to tightening banking system liquidity.

 

A tweak in the central bank's intervention strategy may have also come on account of the subdued outlook for foreign fund inflows going ahead. The RBI can only spend so much when it knows that the opportunities to restock its forex buffers will be few and far between in the coming times, market players said. "The Indian rupee is facing headwinds from both global and local factors. The Federal Reserve's decision to adopt a cautious approach toward rate cuts in 2025 triggered a more than 1% correction in Indian equities," Pabari said.

 

With the central bank's loosening grip on the currency, the rupee's move to the next big-figure -– the-86-per-dollar mark -- may not be too delayed. Most participants expect the rupee to test 85.50 a dollar by next month and 86.00 by the end of the current financial year.

 

"Continuous pace of intervention (by the RBI) at this stage will be challenging. I do think the March target can be around 85.50-86.00. We have been better performing currency in the whole bucket. The gap between our and US 10-year yield has narrowed. That will lead to pressure on FII flows in the debt side as well. The macro level indicators are not showing good signs too," said Anshul Chandak, head of treasury, RBL Bank.

 

Nevertheless, market participants are almost certain that the central bank will continue to provide a cushion to the rupee through its interventions in the coming times. However, the Indian currency's performance in the last few months and the lack of a silver lining on the horizon for the local unit has cemented the view that the RBI's earlier strategy has indeed undergone a much-needed change.  End

 

US$1 = INR 85.0150

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

 

Edited by Avishek Dutta

 

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