Informist, Friday, Jul 26, 2024

By Pratiksha

NEW DELHI - The rupee is theoretically a market-determined currency, but since last year, it is the Reserve Bank of India which has held the steering wheel. And currency traders say that the central bank is now steering the rupee southward.

The Indian rupee has depreciated 0.4% against the dollar so far this month, falling to successive record lows tracking weakness in the Chinese yuan. Moreover, portfolio investors' appetite for Indian equities has taken a beating after the Union Budget for 2024-25 (Apr-Mar) on Tuesday proposed raising the long-term capital gains tax on all financial and non-financial assets. Since the Budget has been presented, foreign portfolio investors have pulled out funds worth $866.8 bln from the domestic equities market.

The only reason the rupee has made it past the psychologically crucial levels is because the RBI allowed it to, which suggests that the central bank is guiding the currency towards a gradual depreciation.

After hitting a record low of 83.7300 a dollar during the day, the rupee closed at a record closing low of 83.7275 a dollar today. In the last five days, the rupee established four new record lows. Before the latest spate of record lows, the RBI would deftly fend off any depreciation pressure that was seen pushing the domestic currency towards an all-time low. Case in point, it took the rupee a month to revisit the 83.67 level. Before that, it repeatedly tested the 83.60 level but was reined in by the RBI.

Given the tight grip held by the apex bank on the rupee for so long, market participants had expected a much stronger trigger for the Indian unit to test record low levels. Although the RBI has seen selling dollars in the spot and offshore non-deliverable forwards markets to limit sharp swings in the exchange rate during the day, it has not been very aggressive in doing so.

When it actually comes down to protecting key levels, the central bank has been known to go all guns blazing in its defence, provided it wants to. Armed with foreign exchange reserves which are at an all-time high, the RBI could have come to the rupee's rescue once again without breaking a sweat. India's foreign exchange reserves hit an all-time high of $670.86 bln as of Jul 19.

It does seem like the central bank is not only on board with the domestic currency adjusting to successive weaker levels, but also guiding it there by stepping in to buy dollars at levels where it was selling just over a month ago.

Dhiraj Nim, FX strategist at ANZ Banking Group, thinks that the central bank has been conservative in its dollar sales to protect rupee depreciation. "This has been a classic gradual adjustment, like the RBI prefers. The interesting bit to see is how the rupee behaves as the yuan is strengthening, treading yen moves. If the rupee does not strengthen, it will reinforce the RBI's preference for a weaker exchange rate, not just a stable one," he said.

Market participants said that the central bank may be allowing some depreciation in the local unit due to the rupee being overvalued in comparison to its trading partners. The rupee's real effective exchange rate against a basket of 40 currencies, in terms of trade-based weights, rose to 106.54 in June, its highest level since December 2017. A rise in a currency's REER is an indication that the country's exports are becoming expensive and it is losing trade competitiveness.

They also pointed out that July so far has been a month of robust foreign fund inflows. The domestic equity market saw inflows to the tune of $4.03 bln, while the debt market saw inflows of $2.3 bln. But none of this had any impact on the exchange rate as the central bank consistently absorbed all the dollars.

The sharp fall in the currency also comes in the face of a 1.5?ll in the dollar index on the back of growing expectations that the US Federal Reserve could start cutting rates starting September. In fact, the rupee has been the worst performing emerging market currency after the Taiwan dollar this month.

"The RBI's intervention strategy has been perplexing. They have bought at 83.50 kind of levels, which has not given rupee any space to rise," a senior treasury official at a state-owned bank said. "But now they are letting it (rupee) go down, which means they prefer depreciation but no gains."

The RBI could be nudging the rupee to not only shed its overvaluation, but also to catch up with its evolving fundamentals which are pointing towards medium-term depreciation more strongly than before, dealers said.

"We see no sign of change in RBI's pursuit of higher reserves buffer which would limit the appreciation potential for the Indian rupee. Over the medium term, it would also be prudent for the RBI to allow higher volatility in INR. Along with the policy of building a large reserves buffer, that could create more asymmetric risks for India rupee depreciation trend," Bank of America said in a report on Wednesday.

Market players flagged that some of the announcements from the Union Budget for 2024-25 may also hamper foreign inflows into the Indian share market in the long term. In the Budget, Finance Minister Nirmala Sitharaman announced an upward revision in long-term capital gains tax to 12.5% from 10%, and an increase in short-term capital gains tax to 20% from 15?rlier. She also announced a hike in the securities transaction tax on futures and options to 0.02% and 0.1%, respectively. Market participants are of the view that these tax hikes may discourage investors to invest in the domestic equities market, particularly in futures and options market, in the long term.

"The revamp of these tax structures, while aiming to boost compliance with the new regime, could impact market dynamics and investor sentiment. The higher capital gains tax rates might discourage speculative investments and impact market liquidity, potentially creating a downward pressure on the rupee," Amit Pabari, managing director, CR Forex, said.

Additionally, market participants pointed out that the government's decision to reduce customs duties on gold and silver to 6% from 15?rlier, will potentially increase the demand and import levels of these commodities, which will, in turn, worsen the trade balance and exert additional pressure on the rupee going ahead. In a knee-jerk reaction, gold importers have stepped up their dollar purchases since the announcement of the customs duty cut.

While most market players see the Indian unit in the range of 83.00-84.00 a dollar for the rest of the current financial year, this month's movement has sent a clear message to them that no matter how predictable the RBI's intervention game gets, there could still be surprises in store.

Market participants expect the depreciation of the Indian unit to persist in the near term, but once the US Federal Reserve embarks on its rate-cut cycle, they expect a slight appreciation. "If dollar goes down, there could be some appreciation in the rupee but not much. If it doesn't, I expect the weakening bias to persist," Nim said. End

US$1 = 83.73 rupees

Edited by Tanima Banerjee

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