Informist, Tuesday, May 24, 2022
By Richard Fargose and Pratiksha
MUMBAI – Over the past few months, the Reserve Bank of India has brought out the heavy artillery to defend the rupee, but another significant drop in its arsenal of reserves will be alarming for foreign investors, says Abhishek Goenka, founder and chief executive officer at IFA Global, a treasury and wealth management company.
"To limit major depreciation in the currency, the central bank has used some of its reserves," Goenka told Informist in an interview. "The current levels of foreign exchange reserves seem to be adequate for our current imports of 10-11 months. Another $30 bln-$40 bln will ring alarm bells for any foreign institutional investors, who are already spooked by increasing oil prices."
India's foreign exchange reserves stood at $593.28 bln as on May 13, down around $49 bln from the peak in October. During the same period, the rupee depreciated over 9% against the US dollar as the war between Russia and Ukraine, as well as the prospect of policy tightening by major central banks pushed emerging markets out of favour.
Although the rupee is seen on a relatively firm footing compared with other emerging market currencies, Indian policymakers may find it incrementally more challenging to manage the external sector if the global situation does not start improving in the medium term, Goenka said.
"...We need to see things reversing in the next 6-12 months and oil coming down below $100 a barrel, otherwise it will be a Herculean task for the regulators to hold onto reserves," he said. "Hence, the rupee and our broad gauges such as current account deficit will go for a toss."
Goenka expects the rupee to depreciate more from current levels and head towards the 79-per-dollar mark, but not as volatile as it was in 2012-13 (Apr-Mar) due to RBI interventions.
Following are edited excerpts from the interview:
Q. With most central banks fighting elevated inflation, policy rates are going to be higher for longer and emerging markets are more vulnerable in such conditions. How well is the Indian economy placed to handle a reversal of fund flows?
A. Markets will remain on the edge in the near term over fears of recession and prospects of aggressive monetary tightening by the US Federal Reserve. Despite the turbulence associated with monetary tightening in advanced economies, the ongoing geopolitical conflict, lockdowns in China, and the supply-side disruptions in their wake, India is relatively better placed than most other nations to weather the storm and achieve steady growth during the current financial year. Having said that, we need to see things reversing in the next 6-12 months and oil coming down below $100/bbl, otherwise, it will be a Herculean task for the regulators to hold on to reserves. The rupee and our broad gauges, such as the current account deficit, will go for a toss. We hope domestic institutional investors keep buying and hold on to the indices as seen in the past few months.
Q. Most central banks, especially the Fed, are taking a route of aggressive monetary policy tightening. Do you think the RBI's Monetary Policy Committee will give more weightage to external factors than domestic ones?
A. The RBI is expected to aggressively tighten policy in the next meeting after minutes of its policy review revealed that rate-setters pitched for front-loading hikes amid a worsening inflation outlook. Inflationary pressures, worsened by war-induced supply-chain disruptions, lifted prices of commodities and have started to impact domestic consumption. Retail inflation rose to an eight-year high in April, while wholesale prices for the same month were the highest in three decades on the back of domestic and global cues. The surging domestic inflation, historical outflows, and elevated crude prices have forced RBI to prioritise inflation over growth as the effect of global economic factors start becoming visible in the domestic macro picture too. Moreover, food and oil inflation will soon have a second-round effect.
Q. The rupee is also facing heat from elevated Brent crude prices, and consequently, a widening current account deficit. With high oil prices, and the Russia-Ukraine war expected to be prolonged, what could be a silver lining for the rupee in the near term?
A. The slide in the rupee was expected, given outflows, inflation, and a strong dollar. Without these reserves and RBI's push to hold to the rupee, we would be at 80 plus (a dollar) surely. As compared to other emerging market currencies we are so much better off in relative terms. In fact, we are 3-4% stronger. The only silver lining is that till our reserves hold above $580 bln, equities hold above 18-19 times price–earnings ratio and DIIs' investments hold strong, and 10-year bonds are capped at 7.60%, we should be fine. Lately, we have started seeing investments through the variable rate reverse repo route, which is good news for bonds and flows.
Q. Do you see any possibility of a fresh rupee-rouble trade pact for oil imports from Russia?
A. Considering India's oil consumption and the rate at which Russia is offering crude, there is the possibility of a fresh rupee-rouble trade pact for oil imports from Russia. The possibility of these pacts remains till Europe keeps buying oil from Russia.
Q. With the rupee hitting a fresh record low, how big a concern is it for the RBI and the government?
A. Widening trade and current account deficits, heavy foreign fund outflows and a strengthening US dollar have pulled the currency down nearly 4% this year. Oil has been hovering around $100 a barrel for more than two months now and a weaker rupee will add to imported inflation. Having said that, the impact is not so big as of now, the depreciation is fairly in control and the RBI is doing a pretty fair job by doing active interventions through spot sales and also doing buy-sell swaps in forwards. They have brought the liquidity down to around 5 trln rupees and hence, could participate in OMOs actively and maintain the yields when necessary and also keep supporting the government as and when required.
Q. Recently, currencies like the Chinese yuan and the Japanese yen have seen a steep fall. Is the effect of poor-performing Asian peers visible on the rupee too? Where do you see the rupee in relation to its Asian peers?
A. Short positions in China's yuan rose to a record as investors piled up bearish bets on all Asian currencies on concerns over a slowdown in the world's second-largest economy and broadening global price pressures. Bearish views on the Indian rupee rose, as soaring inflation amid elevated oil prices raised fears of another interest rate increase in June after a 40-basis-point hike in an out-of-turn meeting earlier this month, Compared to most of the Asian currencies, the rupee has been resilient due to strong fundamentals and also timely intervention by the RBI to protect rupee levels from any major depreciation. Compared to other Asian peers, the rupee is expected to perform better but it is a contrast to our broad policy of keeping the rupee weaker than the yuan over the last many years. The rupee will catch up sooner or later once the yuan becomes strong again.
Q. A higher trade deficit, relentless selling by FPIs, and rising commodity prices point to higher demand for the dollar. In such a scenario, how logical is it for the RBI to manage exchange rates?
A. The RBI has been seen defending the Indian rupee by intervening in the forex market, and in the process risking depletion of its foreign exchange reserves. The most obvious reason is that a weakening exchange rate increases the country's import burden. The central bank of a net importing country is justified in defending its currency during bouts of depreciation. Our quality of reserves is not very great, which we had piled up in 2020-21 because of huge inflows in equities and record foreign direct investment flows etc--it's payback time now. Intervention through dollar sales also helps in reducing system liquidity, which was the need of the hour and may help fight inflation.
Q. Considering the psychological importance of forex reserve levels, how much window does the RBI have to spend reserves to curb forex volatility, given these reserves have declined below the $600-bln mark? What is an alternative path to prevent sharp depreciation in the rupee?
A. The central bank, to limit major depreciation in the rupee, has used some of its reserves. The current levels seem to be adequate for our current imports for 10-11 months. But another $30 bln-$40 bln will start ringing alarm bells for any FII investor, who have already been spooked by the increasing oil prices. Oil prices have a history of creating large deficits and inflation for India. The alternative to prevent depreciation could be to open some windows to attract debt flows in the country, which has hit rock bottom, maintain FDI, which is going at a good rate, ration other forms of import, and of course, figure out a way to buy cheap Russian oil.
Q. What do you think will be the rupee's trajectory for the next 6-9 months?
A. Overall, the trend of the rupee would be slightly weak. It may depreciate more from current levels--may head towards 79/$1, but we may not see a very volatile rupee as we witnessed in 2012-13 since RBI intervenes in various ways to keep a check on the volatility including spot market, futures, non-deliverable forwards, verbal communications, swap windows, among others. End
US$1 = 77.63 rupees
Edited by Shirsha Thakur
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