RBI may have to change its currency strategy and allow the rupee to weaken: experts

Over the past few days, the Rupee has hit a series of record lows and is currently hovering around 79 against the US Dollar on concerns about economic growth amid multi-year high inflation, interest rate hikes interest, continued outflows of foreign funds, high crude oil prices, and volatile domestic equities are weighing on sentiment.

The rupiah’s weakening has accelerated since last month, with global markets seeing a massive bearish tone amid recession fears due to macro risks. The US Fed took an aggressive approach to raising key interest rates to keep inflation under control, which strengthened the greenback against a basket of currencies that included the rupee. Further rate hikes are expected not only from the US Fed, but also from other major central banks.

In the interbank foreign exchange market on Wednesday, the Indian rupee closed at an all-time low of 79.04 to the dollar, down 19 paise.

According to Reuters experts, to control the weakening of the rupee, RBI sold dollars in the spot market and simultaneously bought and sold in the futures market.

Traders told the news agency that RBI’s actions in the onshore futures market have caused premiums to fall sharply, with the annualized 1-year futures premium now below 3% levels seen for the last time in November 2011, wiping out gains from the carry trade and putting pressure on the spot rupee. Lower price.

Radhika Rao, senior economist at DBS Bank in the Reuters report, said: “Expiring futures contracts are believed to weigh on the currency this week, on top of an unfavorable macro backdrop of portfolio outflows, oil high and dollar bid.”

Notably, these technical conditions made intervention in the futures market a less than ideal tool to control the volatility of the rupee and reduced the RBI’s options to reduce the risk of capital flight.

The central bank could resort to more intervention in the spot market – which would reduce central bank reserves – or could simply choose to let the rupee weaken depending on macroeconomic fundamentals, according to the report.

Rao said that in the short term, the intervention strategy could backtrack to meet dollar demand, in light of a sharp drop in transit premiums.

Meanwhile, Madhavi Arora, senior economist at Emkay Global, said declining foreign exchange reserves, continued high commodity prices, limited exchange rate pass-through to inflation and lofty valuations of the INR will likely tip the scales towards a less interventionist exchange rate policy in the coming months, Reuters quoted.

India’s foreign exchange (forex) reserves fell for the third consecutive week to $590.588 billion as of June 17, 2022. Foreign currency assets fell to $526.882 billion, while gold reserves fell to $40.584 billion, according to weekly data from RBI.

Arora added that allowing the INR to slowly weaken over time is the right strategy, giving the CAD room to improve.

In its note, QuantEco Research said they expect the INR to weaken towards 81 per dollar before the end of FY23.

Looking ahead, Jigar Trivedi – Research Analyst – Commodities & Currencies Fundamental, Anand Rathi Shares & Stock Brokers said, “We expect the Rupee spot to depreciate towards the 80/81 levels by the end of the year as twin deficits add pressure on emerging currency Fed set to hike rates 75 basis points at July meeting, while RBI meeting not scheduled than in August, which could narrow yield spreads between India and the US and could further weigh on the rupee.”

In his monetary policy statement earlier this month, RBI Governor Shaktikanta Das said: “Several EME currencies thus faced depreciation pressures. Safe haven demand for the US dollar increased. of all this, the indian rupee has moved in an orderly fashion and has depreciated 2.5% against the u.s. dollar in the current financial year so far – faring much better than many of its peers EMIs.”

The monetary policy was announced on June 8 and since then the rupee has depreciated further.

Last month, Das said the rupiah was determined by the market, but the RBI would not allow a “rampant depreciation” of the currency.

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