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Will RBI’s juggling activity keep rupee volatility and range in check?

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Over the last 1.5 years, RBI’s KRA (Key Result Area- define the job profile and role) has become extensive due to the requirement of changes in policy during the COVID crisis to support and revive the economic activity.

Will RBI’s juggling activity keep rupee volatility and range in check?
Every importer and exporter should definitely keep this RBI’s tagline in mind- “Jaankar Baniye Satark Rahiye”. Not just for any fraudulent activity, but against any uncertain movement in the forex market too. One has to be a “Jhankar”- know what RBI is doing and “Satark”- when RBI is turning their stance. They should keep an eye on how RBI is managing both the segments of the Forex market- Spot & forward and continuously building their FX reserves.
Over the last 1.5 years, RBI’s KRA (Key Result Area- define the job profile and role) has become extensive due to the requirement of changes in policy during the COVID crisis to support and revive the economic activity. We should definitely appreciate their commitment and their work towards a timely call on the policy and managing volatility in the Rupee. They have also come up with various swaps in the currency market and operations in the bond market like G-SAP regularly.
When financial markets worldwide were facing intense selling pressures on extreme risk aversion due to Pandemic, the RBI undertook a 6-month dollar Sell/buy swap to provide liquidity to the FX market. Major central banks across the world chose to loosen their policy immediately and had started flooding billions of dollars into the market. As their interest rates were constrained near zero, they started unconventional tools- forward guidance (managing future short-term rates and yield) and the purchase of government bonds or quantitative easing. The RBI had also conducted many OMO programmes to support the government’s fiscal plan and cool down the yield. The Rupee had touched a dramatic all-time low of 76.94 before recovering back on higher liquidity.
As flows were chasing riskier assets, EM markets and currencies including India had started to recover their losses. The FDI, FII flows had been high. Exports activity was seen recovering but imports remained sluggish as the domestic economy was in lockdown. All these were suggesting Rupee’s appreciation and thus exporting goods uncompetitive to the peers. To keep valuation in check, RBI had been buying dollars and injecting Rupee into the banking system. Very high Rupee liquidity in the system could lead to directionless lending activity and higher inflation.
So to manage that, RBI started conducting a swap in FX- Buying in the spot market and then does Sell-buy swap (Selling dollars to the commercial banks with an intention to buy it in a future date, i.e. forwards long). The buying in the spot market led to a soaring RBI’s FX reserves, which increased from ~$474 billion at the end of FY2020 to ~$579 billion at the end of FY2021- a rise of more than $100 billion or 22 percent. An intervention in the forward market was also seen at a record high. RBI’s long position at the end of March 2021 jumped to $73 billion compared to a negative $5 billion one year ago. As a result of this, forward premiums too were shooting above 5.25 percent for several months or we can say that RBI was paying a hefty premium, versus a 1-year T-Bill yield of 3.50-3.75 percent.
Further, it is said that RBI intervened through forwards because they wanted to maintain their balance sheet under control. This intervention was mainly aimed to hedge against hot money flows like FII, permanent flows like External Commercial Borrowings (ECB), Foreign Currency Convertible Bonds (FCCB), and Rupee Denominated Bonds (RDB).
Now in the current FY-2022, the RBI is offloading or liquidating those long forward positions and either taking delivery of it or selling the forwards. And hence, premiums in Q1 FY22 have fallen down drastically to 4.3 percent.
Let’s check the current position of the RBI, inflow status, and trade balance position and try to analyze how everything is managed and its implication on the forex market:
The above table is very much self-explanatory. In total, we are having total inflows (hot and permanent) worth approx. $55.86. If we look at RBI's stance in the forex market then they have increased their FX reserves by $52 billion and currently holding approx. $40 billion (assuming $5 billion fall in reserves for July and Aug each). And India’s trade balance currently stands at a deficit of $13.87 billion. For the calendar year 2021, we are in a net trade deficit of $96.71 billion. Matching the inflows against the outflow, we can assume that hot and permanent inflows worth $55.86 and forwards (maybe this will get converted into spot and added into FX reserves) worth $40 billion are enough to adjust against the trade deficit figure. Still, RBI will be left with FX reserves worth $52 billion.
The RBI is currently facing a hurdle to increase their reserve as there is an ‘Excess liquidity' in the banking system. To increase their dollar reserves further, they have to buy it in the spot market and that could increase their balance sheet & hence could lead to higher Rupee liquidity in the market. To address this issue, RBI in August monetary policy announced VRR (Variable Reverse Repo) operation worth Rs 4 lakh crore. This week also, they have conducted a special 7-day VRR measure of Rs. 50,000 crore. This will give leeway to RBI for intervention and make room to pile up their dollar reserves. The premium markets are currently stable near 4.20 percent-4.50 percent. However, the unwinding of forwards could keep pressurizing on the forwards.
Outlook:
In nutshell, RBI will continue to act as a ‘Juggler’ and balance the forex market, FX reserves, banking liquidity well. They will ensure sufficient liquidity in the market to support the growth and revival of the economy but at the same time try to suck out excess liquidity from the market. This will help them to intervene and buy dollar from the spot. Moreover, they will try to keep working for uncertainty on a global level too where Fed is expected to lift off the bond-buying support and Yuan is appreciating against Rupee. At last, one can say that RBI is managing their KRA very well by keeping dollar-rupee volatility under a tight range of 72.30 to 75.50. This range is still not broken over the last 1 year and unlikely to break till the time the weighing scale would switch either side due to heavy triggers.
—Amit Pabari is the managing director of CR Forex Advisors. Views expressed are personal.