R.B.I. is prepared to spend an additional $100 billion to preserve the rupee.
According to a senior source familiar with the central bank’s thinking, India’s central bank is willing to sell a sixth of its foreign exchange reserves to protect the rupee from a sharp decline after it hit historic lows in recent weeks.
On Tuesday, the rupee plummeted past the crucial mark of 80 against the dollar, losing more than 7% of its value in 2022, but the source claimed that the collapse would have been much higher if the Reserve Bank of India (R.B.I.) had not intervened to stop the slide.
Since reaching a peak of $642.450 billion in early September, the R.B.I.’s foreign exchange reserves have decreased by more than $60 billion, primarily being a result of dollar selling intervention but being a result of value changes.
The R.B.I.’s $580 billion in reserves, which rank fifth in the world despite the decline, give the central bank confidence that it can stop any sudden, abrupt devaluation of the rupee.
“They’ve demonstrated that they’ll spend reserves like needed to stop rupee volatility. They have the resources and have shown a willingness to use them, “said the insider.
The insider continued, “The R.B.I. can afford to spend even $100 billion more if necessary to safeguard the rupee.”
According to the source, the R.B.I. will take action to prevent any excessive currency depreciation rather than trying to safeguard the rupee or keep it at a specific level.
A request for comment from the R.B.I. was not immediately met with a response.
The Federal Reserve’s relentless monetary tightening and the ensuing race by investors to sell riskier assets in favor of dollars are driving the broad and persistent U.S. dollar surge that is causing the rupee to fall in line with what is happening globally.
Given the rise in commodity prices, particularly oil, which accounts for a sizable portion of India’s import bill as a result of the Russia-Ukraine crisis, both India’s trade and current account deficits seem destined to get worse.
According to Charu Chanana, a markets strategist at Saxo Capital Markets, “there is no doubt that a major portion of the rupee decline is related to the U.S. dollar strength and higher oil prices, but the R.B.I. has been behind the curve despite inflation remaining above the midpoint target for almost three years at this point and growth momentum still strong.”
“This trend could reverse as the dollar climbs,” according to the continuing strength of India’s macroeconomic fundamentals.
Since January, the monthly trade deficit has averaged $25 billion, which suggests that a $100 billion intervention fund to directly counter the demand for dollars would last just four months. Foreign investors have sold roughly $30 billion worth of shares so far in 2022.
WORSE IS YET TO COME
Despite the Reserve Bank of India’s (R.B.I.) intention to defend the rupee and India’s good macroeconomic fundamentals, the majority of analysts and traders believe the rupee’s worst days are yet to come.
Given the global context of rate increases and quantitative tightening, it is quite improbable that foreign portfolio investors will return to India quickly, according to a top trader located in Singapore.
“The absorption of dollar liquidity is only getting started.”
Authorities anticipate that foreign investors will return to the market in the next month or two after a number of actions by the government and the central bank, but investors are still hesitant.
“Since the U.S. has recently begun quantitative tightening, money would be leaving India. I would engage in a trade for long dollars. The rupee must exceed its true value. With ease, we may reach 84 to 85 before the market turns, “Added a second trader.
Why R.B.I. will not let the rupee fall much
When the base effect and monetary policies can lower headline inflation in the upcoming months, a dropping rupee may increase it, so the R.B.I. must take all necessary measures to safeguard it. Here is a brief explanation.
To stop the rupee’s decline, the Reserve Bank of India (R.B.I.) engages in daily combat on the Forex market.
Even though the rupee depreciated against the dollar in the end, the Reserve Bank of India’s sales of the dollar in the local spot and futures markets allowed it to recover a size-able percentage of those losses. The rupee ended the day at 77.4150 against the dollar after hitting a record low of 77.6250 on Thursday.
This stands in stark contrast to the beginning of the year when analysts had expected that the rupee’s devaluation beyond 78 per U.S. dollar in 2022 was unlikely due to the country’s large foreign exchange reserves and excellent performance against its counterparts around the world. In reality, it was expected that the currency would rise to 72 to the dollar.
But the unit has been thrown on its head by a sudden increase in inflation and a conflict. To stop the decline of the rupee, the Reserve Bank is spending an average of $6 billion per week.
If the present slide persists, experts predict it may exhaust its $100 billion in reserves in just four months.
The R.B.I.’s involvement
The R.B.I. is intervening in the domestic currency market to stop further rupee depreciation and to keep it above the psychologically major threshold of 77.50 to the dollar. The R.B.I.’s actions are consistent with the attitude of the monetary policy since they keep the rupee from falling out of control, which lessens the impact of imported inflation.
India is a net importer. Hence it is the responsibility of the central bank to protect the currency when it is falling in value.
The already high inflation rate will increase by 20 basis points with a 5% devaluation of the rupee from the R.B.I.’s baseline assumption of Rs 76 per dollar.
However, in a setting of important financial and commodity market volatility, “the exchange rate pass-through to inflation can be non-linear and time-varying.”
The central bank cannot allow the currency to remain erratic due to excessive inflation.
The central bank’s hasty decision to raise interest rates in an off-cycle meeting can be explained by the strong increase in retail inflation in April. This decision will probably be supported by a second rate increase in the upcoming monetary policy review in June. Though it will still be above 6.5 percent, economists anticipate base effects will cause May’s inflation rate to slow down.
While the base effect and monetary actions are anticipated to drive down headline inflation, the recent decline in the rupee may do the opposite. Due to the currency decline, the central bank may decide against taking the chance of missing its inflation objective.
Imported price rise
Not only is inflation increasing more quickly than anticipated, but it is becoming widespread: This fiscal year, all three engines—food, fuel, and core—are anticipated to advance. The R.B.I. was no longer able to view inflation being a supply-driven phenomenon despite the fact that demand had been weak.
According to export price indexes of nations that make up a major portion of India’s imports, the high import price inflation of 26.9% on year in fiscal 2022 was mostly caused by rising crude oil, metal, and edible oil costs.
The Gulf Cooperation Council, which includes major oil exporters like Saudi Arabia and the United Arab Emirates and makes up the top five countries/regions accounting for roughly 60% of India’s imports, experienced the highest import price inflation in 2021, at 33.6 percent, largely being a result of the increase in crude oil prices.
Export price inflation was higher in developed economies like the United States and the European Union than it was in developing nations like China and the Asia-Pacific region (Association of South-East Asian Nations).
The crisis between Russia and Ukraine is continuing to drive up commodity prices. Therefore India’s import price inflation through its main importing countries is unlikely to slow down anytime soon.
Through the W.P.I., this will contribute to domestic inflation along with the rupee’s depreciation. Producers are projected to pass on their high expenses to consumers in the form of higher retail prices this fiscal year being a result of the high costs already weighing on their margins.
The recent currency depreciation could increase headline inflation at a time when the base effect and monetary policy would normally drive it down.
Expectations of inflation
According to the most recent surveys, families’ and analysts’ forecasts for inflation have increased. In fact, since the pandemic’s onset at the beginning of fiscal 2021, household inflation expectations have been rising upward and are at present at their highest point.
Business forecasts of inflation serve as further support for the economy’s growing inflationary pressures.
The one-year-ahead business inflation predictions increased to 6.12% percent in March from 6.09 percent in February, according to the IIM-Ahmedabad Business Inflation Expectations Survey, the survey’s highest figure ever since it began in May 2017.
These accurately reflect the cost-side aspirations of enterprises. The anticipated inflation probably increased more as commodity prices rocketed following February and are predicted to stay high and volatile in the near future. Businesses often set prices. Therefore higher cost pressures they encounter may contribute to actual inflation results.
In its most recent monetary policy meeting, the R.B.I. sharply increased its inflation prediction for this fiscal year (to 5.7 percent from 4.5 percent before), reflecting the broad-based inflationary pressures in the economy.
As a result of the strong U.S. dollar, ongoing outflows of foreign funds, declining foreign currency reserves, and rapidly expanding trade and current account deficits, the Indian rupee has remained close to its historical low of over 79.9 per USD.
Around $30 billion in Indian shares have been sold by foreign institutional investors so far this year as investors fled risky emerging-market assets in favor of the safe haven dollar due to mounting fears of a global economic downturn.
A record USD, 26.2 billion trade deficit was also reported by India in June, along with strong increases in gold imports, which caused local F.X. reserves to drop to a 15-month low. In the meantime, the government increased the import duty on gold from 12% to 12.5% in July. Furthermore, there are rumors circulating that the R.B.I. is setting up domestic dealers.
Additionally, rumors are circulating that the R.B.I. is setting up procedures for domestic traders to settle trades in rupees, days after it increased the amount that may be borrowed abroad and lifted interest rate caps on foreign deposits. However, the rupee wasn’t much strengthened by these actions.
A striking indication of the broad-based inflationary pressures in the economy is the substantial increase in the R.B.I.’s inflation projection for this fiscal year (to 5.7 percent from 4.5 percent before).
Indian rupee holds below 80 a dollar mark, R.B.I. hand suspected
Traders reported that the central bank’s dollar-selling intervention, along with gains in the domestic stock market and a decline in crude oil prices, helped to keep the Indian rupee below the 80-to-dollar threshold on Wednesday.
With the anticipation of a larger E.C.B. interest rate increase this week than initially anticipated and a Reuters story that a crucial Russian gas pipeline would reopen on schedule following maintenance, the euro stayed close to two-week highs against the dollar.
The partially convertible rupee (INR=IN) of India closed at 79.99 to the dollar, down from Tuesday’s finish of 79.94 when it had reached a record low of 80.0650.
The pair should trade between 79.80 and 80.10 this week, according to H.D.F.C. Bank economists who wrote a research note.
In recent weeks, the Reserve Bank of India has aggressively intervened in the market to stop a spiraling decline in the value of the rupee.
According to a senior source familiar with the R.B.I.’s thinking, the institution is ready to sell a sixth of its foreign exchange holdings to protect the rupee.
Stronger local shares, according to traders, improved sentiment, but the rupee will need to recover if foreign fund buying stops. Since the beginning of the year, shares worth close to $30 billion have been sold by foreign investors.
After the government reduced windfall taxes on local crude sales and fuel exports, oil producers and refiners jumped, sending Indian shares to a six-week high. B.O.
“The rupee would stay under pressure as long as there are no new investments entering the market. It’s unlikely that inflows will begin right away, “According to a senior dealer at a foreign bank.
As India imports more than two-thirds of its oil requirements and higher crude increases the country’s trade and account deficit, he said volatility in the price of crude oil would continue to be significant for bonds and the rupee in the interim.
In response to attempts by central banks around the world to contain inflation and in advance of anticipated increases in U.S. crude stocks as fuel consumption declines, oil prices plummeted by more than $1 per barrel.
The benchmark 10-year bond yield IN065432G=CC on the domestic debt market increased by two basis points to 7.45 percent.
Indian rupee wedged in a tight band.
The Indian rupee was kept within a narrow range on Thursday as the central bank’s dollar selling intervention countered initial losses in the currency brought on by weakness in its Asian counterparts, according to traders.
By 0550 GMT, the partially convertible rupee was trading little altered versus its closing price on Wednesday of 79.99 per dollar, trading at 79.97/98.
It dropped to 80.05 earlier in the day, almost missing its previous record low of 80.0650 sets on Tuesday.
Traders reported that state-run banks saw some dollar selling over 80 levels, perhaps on the central bank’s behalf, although advances in the domestic stock market and losses for the dollar versus the euro helped prevent a more significant decline.
Hitesh Jain, senior vice president of institutional research at Yes Securities, wrote in a note, “We think that the worst is priced in the currency, with the value likely to be peaking around 80.5-81.0 against the greenback.”
Given the sharp decline in the price of food, oil, and other industrial commodities, he continued, “We say this because there is a rising signal that inflation has peaked around the globe.”
Analysts reported that while foreign portfolio withdrawals from the domestic stock market also decreased in July, it is still too early to declare a trend change.
The rupee is under pressure due to the approximately $30 billion worth of Indian equities that foreign investors have sold off so far in 2022.
However, after a source claimed the R.B.I. was ready to sell another $100 billion to defend the rupee, investors will continue to be skeptical of the central bank.
Early in August, the R.B.I. will make its next policy announcement. After retail inflation remained above 7 percent in June—the sixth straight month it has exceeded the R.B.I.’s upper tolerance target of 6 percent—the market as a whole anticipates another 50 basis point rate increase.
The benchmark 10-year bond yield was trading at 7.46 percent, up one basis point on the day.
The Rise And Fall Of The Dollar vs. Rupee Since 1947
The U.S. dollar (USD) has been the most dominant currency since World War II. It now serves as the default currency for all international trade and transactions and has dominated the financial market.
The USD is the most widely used reserve currency in the world, making up more than 60% of all foreign exchange reserves. Countries have historically pegged their currencies to the U.S. dollar to decide how much they are worth on the world market.
Also taken into account when comparing the INR to the USD is the strength of the Indian rupee. The exchange rate is the constantly changing value of 1 USD relative to 1 INR.
A significant factor in determining a country’s economic strength is the exchange rate, which fluctuates regularly on the international foreign currency market.
Its existence makes possible all international trade. Imports become more expensive and export less expensive when the value of the foreign currency rises. The exact opposite is also true.
If it costs more Indian rupees to buy one U.S. dollar, the value of the currency decreases, and if it costs less, it increases. The value of the Indian rupee has fluctuated wildly since independence. Over time, its value has been impacted by geopolitical events, economic reforms, and global problems.
According to the current exchange rate of 72.55 rupees to the dollar, the Indian rupee has lost value versus the U.S. dollar during the past 71 years.
To comprehend the rupee’s path of depreciation versus the dollar, let’s look at its relationship with the dollar from 1947.
Rupee Once India gained its independence.
India had no external debt or credit when it became a free nation in 1947. It may imply that 1 USD = 1 INR. The value of INR was determined by the British pound, nevertheless, as India was a British-ruled state before becoming independent. One pound was worth 13 Indian rupees at the time.
Before 1944, there was no accepted method of comparing the different world currencies, so this valuation stayed the same.
Since 1 pound was worth $2.73 at the time, 1 USD equaled 4.76 INR in 1947, according to a conversion table.
Each nation was oligated by the 1944 Bretton Woods Agreement to link the value of its currency to the dollar, which was itself convertible to gold at a rate of $35 per ounce. Since India was a party to this agreement as well, she adopted the par value system of exchange rates at the time of her independence. This exchange rate was not fixed; rather, it was relative.
The breakdown of how the rupee fared against the dollar after 1947 is given below.
1947-Late 1950s
The Indian economy was in a dire situation when India attained independence in 1947.
Starting in the 1950s, the Indian government, led by Prime Minister Pandit Jawaharlal Nehru, regularly borrowed money from foreign or private sector savings to finance welfare and development programs, particularly after the adoption of the five-year plan in 1951. The 1960s saw a sharp growth in foreign borrowing.
Decimalization began in 1957.
The decimalization of the Indian rupee in April 1957 resulted in the creation of 100 “new” paisas. One rupee was divided into 16 annas, or 64 pieces, prior to decimalization. Four pieces are equal to one anna. Both decimal and non-decimal coins were in use for a brief period of time. After decimalization, half and quarter rupees, as well as pre-decimal coins, were still in use. The value and name of the rupee did not change.
In 1964, the prefix “Naya Paisa” was dropped. India’s currency’s decimalization was a significant step toward modernity and revolutionary transformation.
1960s drought and conflict
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Due to a low rate of savings, the Indian government was unable to borrow more money to cover its budget deficit. The Indo-China War in 1962, the Indo-Pakistan War in 1965, and the severe drought in 1965–1966 all made the situation worse. At the time, 24.06 percent of all government spending went toward defense, which was a fairly high percentage.
Up until 1966, one pound was equal to thirteen rupees. After 1966, when the INR and USD were compared one to one, the rupee began to lose value.
The then-Prime Minister had to weaken the rupee to 1 USD = 7.50 INR by 1967 as a result of the economic turmoil. Inflation was caused by the devaluation, which made imports more expensive and exports more affordable.
The Bretton Woods System collapsed in 1971, ending the par value system and the United States of America’s conversion of the dollar to gold.
1971 saw the termination of the Bretton Woods Accord.
After the Bretton Woods Agreement failed, India switched to a fixed rate system and was tied to the British pound sterling.
To preserve the rupee’s stability, however, and to offset the growing imbalances and drawbacks connected with a single currency peg, the rupee was tied to a basket of currencies by 1975.
Due to the Organization of Arab Petroleum Exporting Countries’ decision to cut output following the 1973 oil shock, the value of the rupee fell to 8.10 in 1974. (O.A.P.E.C.).
Economic Crisis of 1991
Since the 1960s, India had relied heavily on the Soviet Union as a trading partner. However, India’s export decreased significantly as a result of the Soviet Union’s fall in the 1980s.
India experienced a severe Balance of Payment crisis in 1991 as a result of the Persian Gulf countries’ 1990 increase in the price of crude oil.
The government received 39 percent of its revenue from interest payments, and the budget deficit dropped to 7.8 percent of G.D.P.
India hardly had the money to purchase enough goods for three weeks because the foreign reserve had depleted to that extent. The nation was on the verge of collapse. India was forced to pledge its gold stockpiles as collateral for a loan from the International Monetary Fund (I.M.F.).
Throughout the 1980s, the currency rate fell precipitously; by late 1990, it was 1 USD = 17.32 INR.
The rupee needed to be devalued because of the economic crisis. Devaluation is the procedure of lowering a nation’s exchange rate on the world market while maintaining its domestic worth. This was done to promote a rise in exports and a rise in foreign money inflow.
As part of a well-thought-out response to the crisis in 1991, the Reserve Bank of India (R.B.I.) reduced the exchange rate by a total of 11% under the auspices of the “hop, skip, and jump” program. With this, India abandoned its fixed-rate currency regime and transitioned to a system where the exchange rate is set by the market or is floating.
Currency Changes in the 2000s
In 1992, the devaluation effect caused the exchange rate of 1 USD to 25.92 INR.
Since then, the Indian rupee has fallen steadily. The rupee had depreciated to Rs 48.99 against the U.S. dollar by 2002.
The persistent foreign direct investment (FDI) inflows into the country in the form of investments in the growing stock market, rising remittances, and growth in exporters headed by the I.T. and B.P.O. sectors in the country caused the rupee to strengthen and reach a peak of Rs 39.27 to the dollar in 2007.
However, the global financial crisis of 2008 reversed the trend, and by 2009, the rupee had fallen to a record low of Rs 51.75. Due to both domestic and international issues, the rupee further depreciated to Rs 56.57 per dollar by early 2013.
Demonetization in 2016
The termination of the Rs. 500 and Rs. 1,000 notes in 2016, known as “demonetization,” caused an overnight loss of roughly 86 percent of the money in circulation. Consumption habits, investment, and income, among other things, were negatively impacted by this. Additionally, the absence of freshly issued notes resulted in less money being in circulation.
Later, new notes of older values such as Rs 10, Rs 20, Rs 50, Rs 100, and another first—Rs 200 note—were produced. The currency in circulation at that point consisted of a new Rs 500 note and a first for the Indian currency, the Rs 2,000 note.
With a rise in the use of cashless transactions as a result of demonetization, demonetization was a strategy to fight corruption and black money in the economy and advance digital India.
1 USD equaled 68.77 INR in 2016, setting a record for the USD to the INR exchange rate.
The currency rate dropped to a record low of 1 USD = 76.67 INR due to the global economic crisis that followed the coronavirus epidemic in 2020. (March).
At the time of writing, the currency rate was 1 USD = 72.55 INR.
N.R.I.’s can now incorporate one-person companies (O.P.C.’s) in India, per the Union Budget 2021
The new budget states that Non-Resident Indians (N.R.I.’s) can form Person Companies (O.P.C.’s) in India without restrictions on paid-up capital (the previous limit was Rs. 50 lakh) and turnover (which was previously capped at Rs. 2 crores), and they can convert into any other type of company at any time.
The member and nominee both had to be Indian citizens in order to qualify for O.P.C. The residency threshold has been lowered from 182 days to 120 days, making it simpler for N.R.I.’s to enter the Indian market.
This action by the Indian government will inspire N.R.I.’s with business acumen to visit India and establish a firm there. This will provide Indian startups with a significant boost, which will increase N.R.I. investment opportunities.
The Indian rupee will benefit more from a potential rise in foreign investment when compared to U.S. dollars.
Why Do Indian Rupee Values Change Against The U.S. Dollar?
The main reason why the value of a country’s currency changes is because it is based on supply and demand.
The total amount of a currency in circulation is known as the money supply. A currency’s exchange rate value increases when demand for it rises, or there is a shortage of it.
The majority of the world’s currencies are purchased and sold on the foreign exchange market based on exchange rates. According to the supply and demand of different currencies on the foreign exchange market, exchange rates fluctuate in value.
What Determines A Currency’s Supply And Demand?
Financial Policy
The central banks’ effective weapon for managing currency supply and demand and, consequently, the exchange rate is monetary policy.
The R.B.I. regulates the movement of the rupee in part by altering interest rates.
For instance, the influx of funds from N.R.I.’s increased when the R.B.I. permitted the banks to raise interest rates on Non-Resident Indian (N.R.I.) rupee accounts and bring them in line with domestic term deposit rates. This increased demand for rupees ultimately resulted in the currency’s gain. Similar to other currencies, the rupee loses value due to a drop in interest rates.
For the purpose of regulating the value of the currency, R.B.I. also buys and sells U.S. dollars on the open market. The following are some more ways the R.B.I. regulates the availability of money in circulation and how it affects the value of the currency:
A bank must maintain a minimum amount of deposits as a reserve according to the cash reserve ratio.
Statutory Liquidity Ratio: The minimal share of deposits that a bank must keep in the form of cash, gold, or other liquid assets.
The rate at which the R.B.I. loans money to banks in exchange for securities is known as the repo rate.
Inflation
A currency’s value is impacted by inflation as well. Prices of goods and services rise when there is an excessive supply of money but no economic expansion. The central bank has the power to change the situation by raising the cost of borrowing money. High borrowing rates deter individuals from making purchases. It instead motivates individuals to make savings.
In essence, inflation is a gauge of how stable the economy is. For luring foreign investment, a low and constant inflation rate is ideal.
In 2013, the rupee lost value against the U.S. dollar in a 15-day period, falling from 55.48 INR to 57.07 USD per 1 INR as a result of rising import demand for the greenback and capital withdrawals by foreign institutional investors from the debt market.
The R.B.I. attempted to stabilize the value of the rupee by selling U.S. dollars from its foreign exchange reserves, but this still occurred.
Economic And Political Situation
A country with stable political and economic circumstances typically has a higher exchange rate because investors are more confident in their investments, and there is significant demand for that currency on the currency market.
The value of currency exchange rates is determined by important economic indicators such as the gross domestic product (G.D.P.), unemployment rate, trade balance, inflation rates, and interest rates.
Political unrest may also have a detrimental effect on the currency’s value. The rupee will weaken as demand declines.
Conclusion
The Indian currency is prone to volatility for a number of reasons. Given that India imports a sizable amount of crude oil, its value has a considerable impact on the INR. The value of the Indian rupee decreases when oil prices rise.
As we previously noted, the decline in foreign investments in the Indian economy, interest rates, and inflation all contribute to the INR’s depreciation. Currency depreciation raises the price of imported commodities, international travel, and tuition for study abroad programs.
It is crucial to remember that a strong currency is not always a positive thing.
During a financial crisis, the rupee’s devaluation benefited the Indian economy. The balance of trade has improved as a result of lower exchange rates. With a floating exchange rate system, a number of internal and external forces, as well as market forces, decide the USD/INR exchange rate.
Depreciation can be a normal outcome for a developing economy like India, and it is expected to persist in the future.
