Rupee broken through 81, posing a policy challenge: let it find its worth or burn forex and raise rates.

  • Sept. 24, 2022, 1:03 p.m.

The rupee broke through the 81-mark against the US dollar intraday Friday, putting policymakers in New Delhi in a bind. The Reserve Bank of India (RBI) has burned through forex reserves at a rapid pace this calendar year to prevent exchange rate volatility—an intervention that many in the market believe is intended to defend the currency at a specific level.

In just eight months between mid-January and mid-September this year, forex reserves have been depleted by almost $90 billion, or approximately an average of $11 billion a month. For the week-ended September 16, India’s forex reserves stood at $545.65 billion, compared with $634.97 billion in the week-ended January 14.

"How long?" asked the CEO of a foreign institutional investor (FII), who did not wish to be named. While sustained high inflation of 7% or higher has prompted the RBI to raise policy rates, the government is eager to maintain GDP growth and create more jobs as several major states vote in the next 12-18 months.

With several agencies cutting the GDP growth forecast to 7 percent or lower, the union finance ministry is in a dilemma over whether an aggressive tightening of monetary policy is the appropriate strategy for India, which faces challenges that may require a different response than western countries. In this context, Finance Minister Nirmala Sitharaman has already said that "RBI may not be as much synchronised as the western countries would do"—in other words, hiking policy rates may not be the best thing for India.

Bumpy road lies ahead.

Growth imperatives and the need to create jobs weigh heavy on the government’s mind with elections in over a dozen states in the next 12-18 months. Instead of sharp rate hikes to contain inflation, policymakers would rather let the rupee depreciate.

Policymakers in the government as well as the RBI are convinced that a large part of inflation is "imported". They are discussing the relative advantages and disadvantages of an "overt" action, such as an interest rate hike, versus a "covert" gradual depreciation of the rupee. "Unlike monetary tightening through rate hikes, which is akin to the use of a sledgehammer, letting the rupee find its level is a better tool to rein in demand," said an official, who did not wish to be named. A depreciating rupee makes imports more expensive and curbs demand.

A depreciating rupee makes imports more expensive and curbs demand.

According to the RBI’s monetary policy report of April 2022, a 5 per cent depreciation in the rupee could result in inflation edging up by 20 basis points while GDP growth could be higher by 15 basis points. So far in 2022, the rupee has depreciated by 8.2 per cent in 2022 against the US dollar. Policymakers in New Delhi seem to be veering towards the view that the RBI should not hold any particular level of sacrosanct. "This (gradual weakening of the rupee) covert measure is better than an overt monetary policy action of hiking rates," said a policy maker who did not wish to be named.

Even today, the rupee closed above 81, "said a senior executive in an FII," pointing to the central bank’s aversion to letting the rupee slip. The Indian rupee breached the 81-mark against the US dollar for the first time on Friday, before settling at 80.98, as the greenback continued to strengthen against all other major currencies following an aggressive rate hike announcement by the Federal Reserve.

In the two days since the Fed announcement on Wednesday, the rupee has lost 1.5 per cent.

It opened at a record low of 81.03 against the US dollar, compared to the previous close of 80.86. The domestic currency fell to an intra-day low of 81.22 per US dollar. The weakness in the rupee also dampened equity market investor sentiments and the benchmark Sensex on the BSE fell sharply by 1020 points, or 1.7 per cent, to close at 58,098.9. The broader Nifty on the NSE lost by 302.45 points, or 1.7, on Friday to close at 17,327.3. Over the last two trading sessions, the two indices have lost over 2.2 percent.

The house is already divided over the quantum and pace of rate hikes by the RBI. There are early but discernible signs of a divergence of views between the government and the central bank on the latter’s monetary action to check inflation versus the former’s imperative to rekindle growth. The three-day RBI monetary policy committee is scheduled to begin on September 28, with the action to be announced on September 30.

The North Block is learnt to be leaning in favour of a benign pace of rate hikes by the RBI rather than the aggressive stand taken by the central banks of developed countries since inflation is being seen as driven mainly by global factors and other concerns about employment and sluggish investment taking precedence over inflation.

Author : Rajdhani Delhi Representative

Rajdhani delhi representative

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