Caution over rupee

RBI must keep an eye on its reserves as dollar strengthens

In the course of the day’s trading, the rupee hit a new low of 80.06 against the dollar on Tuesday. It soon recovered slightly, staying steady and closed the day at 79.95 to the dollar. The currency has lost about 7 per cent of its value since the beginning of the year. Some Asian and emerging market currencies have done worse, a few more have done better. One index of the dollar vs Asian currencies indicates that the general slide for the latter against the former this year is of about 6.5 per cent, indicating that the rupee is doing a little worse than its peers. It has, for example, lost about 1.3 per cent against the yuan in the year to date.

Emerging market currencies have, however, in general done better in the context of a rising dollar than some hard currencies. The Japanese yen, for example, has lost almost 20 per cent in value against the dollar since January 1. Analysts’ expectations for the rupee are more bearish than for most of its peers, expecting it to underperform in the current quarter. These predictions cite the $30 billion of foreign flows that have exited Indian equities this year, the increasing unattractiveness of the real carry trade and the widening trade deficit in India. The forwards market is pricing in a further 3 per cent depreciation against the dollar, and 2.5 per cent in terms of the real effective exchange rate (REER) till the end of the year. One or two other currencies may do worse, especially the Korean won, which is also vulnerable to shifts in global fuel prices.

The onus is on the Reserve Bank of India (RBI) to manage this fraught moment responsibly. There are concerns in both the RBI and in the Union finance ministry about the inflationary effect of rupee depreciation. But the way to fight inflation is through the repo rate. Market participants have said that the RBI has intervened heavily in the foreign exchange trade; it is to be hoped that this is merely to ensure a managed depreciation till the rupee finds a new and lower fair value against the dollar. The central bank data shows that India’s foreign exchange reserves have dropped by as much as $52 billion since March. Some of this is due to the falling dollar value of non-dollar hard currency reserves, and the rest due to interventions in the spot market.

The erosion in the reserves might not be in quantitative terms of great concern when it is compared to the current size of reserves in total. On July 1, the RBI reported reserves of $588 billion, which is much larger than, for example, during the taper tantrum of 2013. This means that there are enough reserves in the kitty to pay for over 10 months of imports. It is when the reserves dip below eight months of imports or so that there has been trouble in the past. Yet there is no question that the RBI and the government should be watchful. A further spike in global fuel prices would have a cascading effect on the import cover of reserves. The RBI, therefore, would be wise to limit its intervention and facilitate a calibrated adjustment in the rupee value.