Effect of dollar mop-up by RBI, rising crude prices and fear of US taper
The rupee has lately been the weakest among BRICS (Brazil, Russia, India, China, and South Africa) currencies. It has lost 2.04 per cent against the dollar (USD) so far this year. In contrast, the Brazilian real, for instance, gained 1.51 per cent against the dollar in this period. There is no lack of strengthening elements for the rupee.
Why the weakness?
One key driver could be the Reserve Bank of India absorbing the dollar influx by selling the rupee and thus not letting it appreciate.
“Looking at the Balance of Payments, between June 2020 and March 2021, we received capital flows of nearly $65 billion and at the same time the spot purchases by the RBI amounted to about $88 billion thus increasing our foreign exchange (FX) reserves to record levels. Also, DXY (dollar index) bounced back sharply from 89.20 levels to test 2021 highs of 93.30 levels once again. Rising crude oil prices is also acting as a headwind,” says Kunal Sodhani, Assistant Vice-President, Global Trading Center, Shinhan Bank.
Mopping-up of reserves has continued in FY22, and FX surged to $611.9 billion as on July 9, 2021 from $516.4 billion a year ago. India is the fourth largest FX reserves holder after China, Japan, and Switzerland.
Crude price effect
With crude oil prices hardening, the rupee’s inverse relationship with the commodity is likely to have created problems. Brent crude has gained 42 per cent in 2021 so far with the current price at over $73 a barrel. The price seems to be sustaining well above the key $70-mark and this significantly adds to the import bill.
India depends on imported crude more than any other BRICS nation — over 80 per cent of its consumption is imported. Thus, an increase in crude price is likely to drag the Indian currency relatively more.
Rising crude can further impact consumer inflation, which is on the rise. Consumer Price Index (CPI) inflation rates for May and June stood at 6.3 and 6.26 per cent, respectively, above the RBI’s upper limit of 6 per cent. While other BRICS countries also saw an uptick in inflation, India faces the problem of further importing inflation should the crude price remain elevated, and this is possibly being priced-in in the exchange rate.
Thirdly, fear of a US taper is also weighing the rupee down. The Fed seems to be in a transition phase, wherein a few members of the Federal Open Market Committee (FOMC) believethat the time is nearing for a change in the current accommodative stance. Given that the inflation in the US has been steadily rising in recent months and hit 5.4 per cent in June — the highest since 2008 — it is making a strong case for the Fed to move closer to tapering and embark on a rate hike cycle subsequent to that.
Rising inflation has steadied the dollar in recent weeks, weighing on the rupee, and it can be assumed that the greenback had bottomed out and henceforth the trajectory could only be on the upside. Indicating the same, the dollar index has bounced off the 89.2 to 89.7 price range thrice this year, forming a solid base.
“The Fed has prepared financial markets well for their taper. However, the Fed turning hawkish will continue to support the US dollar and push the rupee towards 75.40/50 levels in the coming weeks. With the RBI aggressively mopping up flows around 74.20/30 levels, it looks like we might have a floor above 74. Therefore, a range of 74 to 75.50/76 can be seen over the next 2-3 months. On a relative basis, though, the rupee is better placed to face a taper because the reserves offer a strong cushion,” says Anindya Banerjee, Vice-President of Research in currency and interest rates, Kotak Securities.