Informist, Friday, Sep 13, 2024

By Pratiksha

NEW DELHI - The Reserve Bank of India's very public and oft repeated motivation for its interventions in the foreign exchange market is to reduce 'undue volatility' in the rupee. It should probably add the internationalisation of the Indian currency as a secondary but increasingly important objective.

The Indian central bank's stranglehold over the rupee's exchange rate has visibly tightened in the last one year, with even moderate fluctuations seemingly being nipped in the bud so much so that the rupee has moved in a range of just 10 paise on an average in a day since September last year, down from 22 paise in the 12 months ended August 2023.

While the RBI's tight grip over the rupee initially left the markets perplexed, the intentions have become clearer as the central bank and the government added one country after another to its list of partners who are willing to use the rupee to settle bilateral trade payments or use Indian payment systems such as the Unified Payments Interface for cross-border retail payments. These, and others, are all ways through which international use of the rupee is being promoted and sets the ground for the currency to become a global asset not dissimilar to the US dollar. And currency market participants say that the RBI's current foreign exchange intervention strategy is also tailored to serve this goal.

"There's very little volatility in the rupee. In one sense, that could also be an effort to make sure that the internationalisation plan works," Jamal Mecklai, chief executive officer of Mecklai Financial Services, said. "Someone who's thinking of investing in India shouldn't be worried that the currency will collapse."

IN RBI'S IMAGE

The rupee's new-found stability is a far cry from the outrageous gyrations it displayed just a decade ago when the US Federal Reserve's 'taper tantrums' sent the currency to record lows on a daily basis, pushed inflation higher, led to the postponement of one monetary policy announcement, and played a role in the trouncing of the Congress-led United Progressive Alliance government in the 2014 general elections.

What the RBI seems to be aiming for now is to portray the rupee as a stable currency; so stable that those with any exposure to it need not worry about wild swings in the exchange rate – a fear commonly associated with emerging market currencies. Building this image of stability has required exceptional persistence from the RBI and virtually killed exchange rate volatility, market players said.

Since January, the Indian currency has depreciated 0.9% against the dollar, while other emerging market units have fallen between 0.4-4.0%. In terms of performance, the Indian unit was in the middle of the pack.

According to Kenneth Akintewe, head of sovereign Asia debt at UK-based fund manager abrdn, rupee-denominated investments are now a much more structural trade than its emerging market peers. While the volatility in currencies such as the Korean won can wipe out fixed income gains almost entirely, Akintewe said investors can put Indian government bonds in their portfolio and "almost forget about it".

Asset managers worldwide base their investment decisions on maximising risk-adjusted returns, which is the excess returns on an asset compared to the risk-free rate, divided by the total risk associated with the asset.

There can be several types of risks associated with holding an asset, including those linked to the exchange rate, home country of the asset, and interest rates.

At present, the country risk associated with Indian assets is already quite low given the political stability and the economy's resilience. By maintaining a rock-steady currency, the RBI has ensured another type of risk – the exchange rate – has been reduced to near zero. The net result is that the risk-adjusted returns on Indian assets are one of the best in the world due to high nominal returns and relatively low risk.

ENGINEERED STABILITY

Economists are not sure the RBI will get the buy-in it seeks for the rupee given the uncertainty that accompanies artificially engineered stability.

"From the perspective of an international investor, if the currency is made stable because of central bank action, it's not a positive thing. At any point of time you can slip up on this, said Madan Sabnavis, Bank of Baroda's chief economist.

To be sure, the RBI theoretically has infinite space to intervene against currency appreciation, while the constraint to protect against rapid depreciation is its foreign exchange reserves. Thanks to India's improved fundamentals and inclusion in global bond indices, the rupee has not faced downward pressure, while the RBI's reserves are approaching a massive $700 bln.

But what if the tide turns?

"If suppose something drastic happens in the international markets, like say crude oil goes to $150 per barrel, then there'll be a sudden depreciation. Whereas if we let the rupee depreciate in a normal way, it would go along with the market. So, you will never have that severe shock," Sabnavis argued.

The hand-holding of the rupee has already attracted global attention, with the International Monetary Fund in December tagging India's exchange rate regime as 'stabilised arrangement' from 'floating', noting that RBI's interventions possibly exceeded levels necessary to address disorderly market conditions.

While a stable rupee is necessary, it shouldn't be controlled to such an extent that it becomes inflexible and macroeconomic effects can't clear, according to Mridul Saggar, formerly an executive director with the RBI and member of the Monetary Policy Committee, and now Professor of Practice at Indian Institute of Management, Kozhikode.

LONG-TERM FOUNDATIONS

In the RBI's own words, the rupee's internationalisation is a process, not a target. And while a near-constant exchange rate could perhaps help kick-start global acceptance, more structural nuts and bolts must be in place to facilitate a process that could take several decades.

Some of these measures are within the authorities' purview: further liberalisation of the forex market, continued promotion of India as the main centre for price discovery of the rupee's exchange rate, and pushing offshore trading in non-deliverable forwards to Gujarat International Finance Tec-City, or GIFT City.

However, the real drivers of the rupee's global reach are rooted in forces that cannot be cajoled easily either by the government or the RBI. For the rupee to be a truly international currency, the Indian economy needs to become a bigger global force, especially by playing a much larger role in trade. In 2023, India ranked eighth in the world in terms of merchandise imports, with a share of 2.8%. In exports, its rank was 17th, with a share of 1.8%. While the spurt in the number of free trade agreements signed by India in the last two years is heartening, it is yet to join a major trading bloc.

"Our trade relationships, FDI relationships will have to increase to a certain extent where we can use that to kind of enforce internationalisation," said Abheek Barua, chief economist, HDFC Bank.

It has been over two years since the RBI introduced a framework to settle trade in rupees. While the central bank and the government have signed bilateral agreements to popularise the same, the lack of immediate results highlight the long-term nature of the process. In fact, 'long term' is an understatement here. The RBI wants to internationalise the rupee by 2035 – a plan that market participants say is too ambitious. A more realistic timeline for changing the very nature of the economy could be 30 years or more. The RBI may not be able to eliminate rupee volatility for that long. End

US$1 = 83.90 rupees

Edited by Vandana Hingorani

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