RBI’s sterilised intervention fails to yield results, says the bank’s research report
The decline in the rupee, which closed at yet another all-time low on Tuesday, may continue further, cautioned State Bank of India in its research report, Ecowrap.
The Indian unit depreciated to close at 71.57 to the dollar on Tuesday against the previous close of 71.18, down 39 paise. The rupee is weakening amid foreign portfolio investors selling in the Indian financial markets, rising oil prices and widening current account deficit.
“Continued volatile depreciation, we strongly believe, may result in orthodox monetary policy measures such as rate hikes in future, thus slowing down consumption significantly as in 2014,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, SBI. The rupee has depreciated 6.2 per cent since June 2018 when the RBI started hiking rates.
“The rupee is one of the worst-performing among its Asian peers. One of the reasons could be the spike in current account deficit on the back of crude oil price increase. After appreciating marginally in January 2018, the rupee has witnessed depreciation every month,” said the report.
Since the beginning of the year, emerging market currencies have also witnessed volatility and have depreciated considerably on the back of US policies on free trade and a strengthening US economy. The US recovery has made the possibility of rate hikes imminent, and akin to the time of the taper tantrum, the emerging market currencies have tumbled, the report observed.
To stabilise the exchange rate, the RBI has spent nearly $14 billion in Q1 FY19, which has further dented the overall stock of foreign exchange reserves, the report said.
In this regard, the report pointed to the detailed discussion on the cost of continued RBI intervention in the foreign exchange market in the central bank’s August monthly bulletin. The bulletin said intervention in the foreign exchange market through purchase or sale of US dollars, however, could pose other challenges by altering domestic liquidity conditions. While purchases lead to injection, sales result in withdrawal of primary rupee liquidity from the system. This requires proactive management of liquidity consistent with the stance of monetary policy.
Given the inefficacy of sterilised intervention, the RBI may be following a relatively hands-off policy in the forex market for now and, hence, the recent penchant for the rupee to depreciate at a much faster rate, the report said.
For example, it took only one trading day for the rupee to travel 100 paisa on August 13, against a historical average of 17 days beginning April 18 (27 days in 2015), it added.
Costs of sterilisation
“Sterilisation by the RBI comes with associated costs…There are other costs of sterilisation as well, which are, however, difficult to estimate.
“For example, sterilised intervention raises interest payments and subsequently revenue expenditure, squeezing out capital expenditure in the process. We estimate such costs per annum could be around ₹10,000 crore,” the report said.
SBI’s economic research team recommended that the government and the RBI should implement the Standing Deposit Facility (SDF) without any further delay as it has no sterilisation cost. In the interregnum till the SDF is implemented, the RBI must continue with durable liquidity injections through regular open market operation (OMO) purchases to offset the current spate of liquidity withdrawals.