India’s central bank is willing to sell a sixth of its foreign exchange reserves to safeguard the rupee against a fast devaluation after it hit historic lows in recent weeks, according to a report by Reuters citing sources at the bank.
The rupee has lost more than 7% of its value in 2022 and plummeted past the crucial mark of 80 per US dollar on Tuesday, according to a source, but the drop would have been significantly more if the Reserve Bank of India (RBI) had not intervened to stop the slide.
The RBI’s currency reserves have dropped by more than $60 billion from their peak of $642.450 billion in early September, owing to value adjustments but primarily to dollar selling action.
Despite the reduction, the RBI’s reserves of $580 billion remain the world’s fifth largest, providing the central bank confidence in its capacity to prevent a quick, abrupt devaluation of the currency.
“They have shown that they will use reserves at will to prevent volatility in the rupee. They have the wherewithal and have demonstrated the willingness to use it,” the source said.
“The RBI can afford to spend even $100 billion more if required to defend the rupee,” the source added.
According to the source, the RBI does not strive to safeguard the rupee or keep it at a specific level but rather acts to prevent a runaway depreciation of the currency.
The rupee’s decline is consistent with what is happening globally: a broad and continuous US dollar rise fueled by the Federal Reserve’s relentless monetary tightening and the ensuing race by investors to sell riskier assets in favour of dollars.
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India’s trade and current account deficits are also expected to widen further as a result of the Russia-Ukraine crisis, which has caused a jump in commodity prices, particularly oil, which accounts for a big portion of India’s import bill.
“No doubt a lot of the rupee decline is related to the U.S. dollar strength and higher oil prices, but the RBI has also been behind the curve despite inflation staying above the midpoint target for nearly three years now and growth momentum still strong,” said Charu Chanana, a markets strategist at Saxo Capital Markets.
“India’s macro fundamentals remain strong and that means this trend could reverse as the dollar peaks.”
Foreign investors have sold roughly $30 billion in shares in 2022, while the monthly trade deficit has averaged $25 billion since January, implying that a $100 billion intervention fund to directly counter dollar demand would last only four months.
Despite the RBI’s intention to defend the currency and India’s strong macroeconomic fundamentals, most analysts and traders feel the worst is yet to come for the rupee.
“It is very unlikely foreign portfolio investors will come back to India in a rush, given the global scenario of rate increases and quantitative tightening,” a senior trader based in Singapore said.
“We are just at the beginning of dollar liquidity absorption.”
Authorities believe that after a series of initiatives taken by the government and the central bank, foreign investors will return to the market over the next month or two, but investors remain cautious.
“Quantitative tightening has just started in the U.S., that would mean dollars go out of India. I would get into a long dollar trade. The rupee has to overshoot its fair value. We can easily go to 84-85 before the market turns,” a second trader said.
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