Defending the rupee

Market adjustment should not be delayed for long

Indian Rupee
Photo: Brent Lewin/Bloomberg
Business Standard Editorial Comment Mumbai
3 min read Last Updated : Jul 07 2022 | 11:39 PM IST
The Reserve Bank of India (RBI) on Wednesday announced measures aimed at boosting foreign exchange inflows to support the rupee. The rupee is under pressure because of a variety of reasons. Higher commodity prices and increasing imports have pushed up demand for foreign currency. The trade deficit in June, for instance, expanded to $25.6 billion and the current account deficit (CAD) is expected to cross 3 per cent of gross domestic product this fiscal year. While the projected level of the CAD is not particularly alarming, the problem is that India is also witnessing large outflows on the capital account. Foreign portfolio investors (FPIs) have been selling Indian assets for a while and have taken out over $30 billion since the beginning of the year. Capital is flowing out largely on account of rising risk aversion in the global financial system and increasing interest rates in the US.

To be sure, the Indian rupee is not the only currency under pressure. The strength of the US dollar has increased volatility in currency markets across the world, including in developed economies. The Japanese yen and British pound, for instance, have fallen over 9 per cent in the current fiscal year, while the rupee has depreciated by about 4.4 per cent, largely because of the defence posed by the RBI. The foreign exchange reserves of the RBI have come down by over $37 billion since the beginning of the year. Although the RBI still has reserves worth over $593 billion, which is sufficient to deal with external volatility, it has decided to increase its firepower. Among the measures announced, banks will be exempted from maintaining the cash reserve ratio and statutory liquidity ratio for incremental non-residential external and foreign currency non-resident bank deposits for a limited period. It has also given more freedom to banks in terms of offering interest rates on such deposits. Further, it has relaxed rules for FPIs in the debt market and allowed Indian firms to borrow abroad on more liberal terms.

Some experts believe that these steps will have a limited impact because of the overall global risk aversion. Companies, for example, may not be willing to borrow abroad because of the pressure on the rupee. The overall policy direction, however, is worth debating because it could end up increasing risks. Increasing foreign debt, particularly of short-term nature, to defend the currency may not be the best response at this stage. The RBI may be intervening excessively in the currency market to limit the impact of imported inflation and shield firms that have foreign currency debt exposure — over 40 per cent of external borrowings are unhedged.

It’s worth noting here that the global environment is likely to remain uncertain for some time and defending the currency may become increasingly costly and perhaps unsustainable. Since the RBI has ample reserves to quell excess volatility, it should allow the rupee to depreciate in an orderly way. This would not only protect the tradable sectors but also make Indian assets more attractive for foreign investors, which will help stabilise the overall external account and the currency. The inflation problem should be addressed through monetary policy —the RBI has been lagging in this area. Also, it should encourage firms to hedge foreign currency risks. The RBI should not be expected to bear the hedging cost all the time.

One subscription. Two world-class reads.

Already subscribed? Log in

Subscribe to read the full story →
Subscribe to Business Standard digital and get complimentary access to The New York Times

Quarterly Starter

₹900

3 Months

₹300/Month

SAVE 25%

Smart Essential

₹2,700

1 Year

₹225/Month

Save 46%

Super Saver

₹3,900

2 Years

₹162/Month

Subscribe

Renews automatically, cancel anytime

Here’s what’s included in our digital subscription plans

Access to Exclusive Premium Stories Online

  • Over 30 behind the paywall stories daily, handpicked by our editors for subscribers

Complimentary Access to The New York Times

  • News, Games, Cooking, Audio, Wirecutter & The Athletic

Business Standard Epaper

  • Digital replica of our daily newspaper — with options to read, save, and share

Curated Newsletters

  • Insights on markets, finance, politics, tech, and more delivered to your inbox

Market Analysis & Investment Insights

  • In-depth market analysis & insights with access to The Smart Investor

Archives

  • Repository of articles and publications dating back to 1997

Ad-free Reading

  • Uninterrupted reading experience with no advertisements

Seamless Access Across All Devices

  • Access Business Standard across devices — mobile, tablet, or PC, via web or app

Topics :Rupeeforeign exchangeBusiness Standard Editorial Comment

Next Story