How rupee shrugged off the fragile tag and outperformed despite shocks

Amid the global economic volatility unleashed by the Ukraine war and the US Federal Reserve’s aggressive turn towards policy tightening, Indian financial markets have witnessed their share of turbulence.

For Indian market watchers, however, a standout feature of the current phase of volatility is the degree of resilience displayed by the rupee.

So far in 2022, the extent of overseas investment outflows from Indian equities has far outstripped that of the Global Financial Crisis of 2008. From dropping almost 20 per cent versus the dollar during that period, the rupee has held its own fairly well this year.

Not only that, the domestic currency has fared better than many of its emerging market peers.

From closing levels on December 31, 2021 to June 29, 2022, the rupee has depreciated 5.9 per cent against the US dollar, placing it on a firmer footing than the Philippine peso, the Taiwan dollar, the South Korean won and the Turkish lira.

Data compiled by the Business Standard research bureau shows that over the same period, the South Korean won has dropped 8.5 per cent versus the dollar, while the Philippine peso has shed 7.4 per cent.

The Taiwan dollar has lost 6.7 per cent, while the lira has plunged a massive 20 per cent, the data shows. The Malaysian ringgit and the Thai baht have depreciated largely on similar lines as the rupee, losing 5.2 and 5.1 per cent, respectively, against the US dollar.

So far in 2022, the US dollar index, which measures the greenback against six rival pairs, has climbed 9.3 per cent.

In 2022, until now, foreign institutional investors (FIIs) have net sold Indian stocks worth $28.4 billion, National Securities Depository Ltd (NSDL) data shows. In 2008, the year of the global financial crisis, FIIs net sold $11.9 billion worth of equities.

The NSDL data, which goes back to 2002, in fact, shows that over the last 20 years, apart from the year of the global crisis, there have been only two other calendar years in which FIIs were net sellers in Indian financial markets. These were 2016 and 2018.

In 2008, the rupee depreciated 19.22 per cent versus the US dollar, faring worse than the Philippine peso, the Taiwan dollar, the Indonesian rupiah, the Russian rouble, the Malaysian ringgit and the Thai baht.

More recently, during the taper tantrum of 2013, an event which was unleashed by the mere threat of the Fed shrinking its balance sheet, the rupee plummeted 20.6 per cent from May 1 to September 3 – hitting a then all-time low of 67.73/$1 on that day.

Over that period, the rupee fared much worse than 10 other depreciating emerging market currencies – the Taiwan dollar, the Philippine peso, the Singapore dollar, the Indonesian rupiah, the Russian rouble, the Malaysian ringgit, the Turkish lira, the Thai baht, the Mexican peso and the Brazilian real.

The free-fall in the domestic currency at that time was largely brought about by speculation against the rupee amid heavy FII outflows in both stocks and bonds in June, July and August.

However, even as FIIs were net sellers of bonds for 2013 as a whole, they turned out to be large net buyers of equities, with their net inflows clocking in at $12.1 billion, the NSDL data shows. Debt outflows that year stood at $7.9 billion.

A key move that helped ease the pressure on the rupee during the taper tantrum was the announcement by then newly-appointed RBI Governor Raghuram Rajan in September 2013 of a special concessional window for foreign currency non-resident bank deposits. The move attracted $34 billion of inflows.

Transient factors such as overseas flows for investment in recent Indian IPOs aside, the key aspect that has shielded the rupee now is the firepower afforded by the size of the country’s reserves.

Currency experts who spoke to Business Standard said that what sets the rupee apart now is the risk involved in speculating against the currency when the central bank holds the kind of reserves it does. At close to $600 billion, the RBI’s foreign exchange reserves rank as the fifth largest globally.

“I would personally put it entirely down to the RBI. The fact that the RBI is holding it,” said Ananth Narayan, associate professor at SP Jain Institute of Management and Research.

“It already looks something like $65 billion net outflow just across current account, FDI and portfolio flows. Clearly somebody has to supply that. It looks like, therefore, the RBI will have to do a lot of heavy lifting this year to manage the volatility,” said Narayan who has served on several RBI committees in the past.

According to IFA Global’s Chief Executive Officer Abhishek Goenka, it’s not just the size of the reserves that has protected the rupee but also the promptness shown by the RBI in intervening across markets to quell speculation against the currency.

“Over the last few months, it has even been noticed in segments like NDF (non-deliverable forwards) – whenever there have been sharp moves, the RBI has come in and restored order. That didn’t happen earlier,” he said.

The RBI has indeed been expending its reserves at a rapid pace to rein in the rupee amid a surge in global commodity prices and the Fed’s rate hikes.

From an all-time high of $642 billion in September, the RBI’s headline foreign exchange reserves have fallen to $590.59 billion as on June 17. The reserves have dropped by over $10 billion in just two weeks.

During the global financial crisis, the RBI’s reserves were less than half that size. As on March 31, 2009, the reserves were at $252 billion as against $309.7 billion at end-March, 2008, RBI data shows.

From April 26, 2013 to September 6, 2013 – the phase of most turbulence during the taper tantrum – the reserves fell from $296.37 billion to $274.81 billion, the data shows.

The huge increase in the RBI’s reserves has occurred over the last couple of years, primarily due to overseas inflows amid record low US interest rates and an improvement in the domestic current account.

In nominal terms, the reserves rose $99.2 billion in 2020-21 and then $30.3 billion in the last financial year.

In the last fiscal year, the reserves rose $47.5 billion on a balance-of-payments basis as against $87.3 billion in 2020-21. India recorded a current account surplus of $23.9 billion in FY21.

Experts pointed out that with the buffer of large reserves, the RBI is now able to pull off a multi-pronged approach to its foreign exchange management.

“Actually, the RBI’s intervention happens in two ways. One is, of course, foreign exchange interventions; the other is the change in the guidance of policy, which they did on May 4,” said Anindya Banerjee, vice-president, currency derivatives and interest rate derivatives at Kotak Securities.

Higher domestic interest rates improve the returns on Indian assets, increasing their appeal for FIIs.

“A much more frequent intervention in the foreign exchange market and a much more structural intervention through the interest rates – these,” said Banerjee, “are the reasons why the rupee has been an outperformer.”