The ball (Rupee) is in the Reserve Bank of India’s court | The Financial Express

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The RBI surprised the markets by pausing interest rates when the markets had factored in a 25 bps increase. It further revised the GDP growth to 6.5% from 6.4.% and the inflation to 5.1% vs the forecasted 5.3%.

rbiRBI helped curb the steep depreciation of the rupee. 

By Amit Pabari

As the financial year 2022-23 ended, we experienced a supersonic Interest-rate hike across the globe as red-hot inflation dented the savings of common people. The Russia-Ukraine war added fuel to burning crude oil prices which were the major contributors to inflation. As we know the RBI too joined the race of hiking interest in line with global peers.  

A brief recap on RBI’s major action last FY (stance and intervention) 

The RBI followed the path of an aggressive rate hike to avoid narrowing down the interest rate differential between the US and India which made the carry trades attractive. It increased the repo rate by 250 basis points for consecutive 6 meetings, pushing it from 4.00%  to 6.50%. Hence, RBI remained ahead of the curve, helping curb the steep depreciation of the rupee.  In Mar-22, the RBI FX reserves were around USD 600 billion+ which fell to USD 524 billion by Oct-22 it fell due to a revaluation of foreign currency and RBI intervention.

Change in RBI’s forward book and reserves

It is widely known that the RBI manages the USDINR pair by intervening in the spot market as well as the Forward market. Let us understand how the RBI has managed its forward book.

ParticularsRBI Forward position BnRBI FX Reserves
Net Change USD Bn21.4954.26

From the above table, RBI’s forward book suggests that the central bank piled up forward from USD 0.24 billion at the end of Oct to USD 21.73 billion at the end of January, a rise of USD 21.49 billion. The RBI FX reserves on Oct 28 2022 were at USD 524.52 billion, which increased in Mar to USD 578.78, an increase of USD 54.26 billion. This shows RBI is actively intervening on the lower side. Out of this, after adjusting currency revaluation RBI’s net intervention in the spot was around USD 24 billion.

Total InterventionUSD Billion
Spot Buying24
Total Change46

Hence, the RBI has bought USD 22 billion in forward markets and USD 24 billion the spot market, which indicates that the central bank doesn’t want appreciation in the rupee and dips have remained a good buying opportunity. 

RBI’s wind of stance change in the first MPC meeting of the new FY

The RBI surprised the markets by pausing interest rates when the markets had factored in a 25 bps increase. It further revised the GDP growth to 6.5% from 6.4.% and the inflation to 5.1% vs the forecasted 5.3%. However, the governor highlighted that the stance remains accommodative to ensure inflation aligns with the target while focusing on growth.  As the RBI has become dovish, and the US Fed is expected to remain hawkish, it could bring down the premiums and lead to bond outflows due to squeezing interest rate differential which will hurt the Rupee in the longer run. 

RBI’s Role in Center’s fiscal Support

RBI Dividend to the government of India

The RBI pays a dividend to the Government to help with its finances from its surplus profit. The large payout can help the government cut back on planned borrowings and if it manages to meet its revenue targets, the surplus gain can lead to a lower fiscal deficit. Let’s see how much the RBI has transferred the dividend in the last 6 years. 

On average, the RBI has transferred Rs 65,000 crores of dividends, but this year it is estimated that the dividends from public sector enterprises and other investments have been pegged at Rs 43,000 crore for 22-23 as well, which shows it’s very less than the average. 

Major reasons for the same:

  • Under reverse repo, the RBI borrows from banks, while under the repo window, RBI lends to banks. The reverse repo rate is 3.35% and the repo rate is 6.25% due to which more outgo interest will go towards banks, keeping fewer profits in the hands of RBI.
  • Bond yields had increased further since then in most overseas markets with the 10-year US bond yield rising by 175 basis points to 3.50% in the last 12-month period.  When the yield goes up, the prices of the bond drop, leading to a loss in mark-to-market holdings. 

Hence, the lesser the dividend goes to the government, the higher the borrowing the government will have to do to fund its expenses. Thereby putting strains on the fiscal deficit and pressurizing the local currency.

RBI vs. Fed leading to volatility in premiums and yields

Last year, at the start of the financial year the Annualized premiums for the USDINR were around 3.5-4%, where the US Fed’s interest was at 0% and the RBI repo was 4.00%. 

As seen, the US Fed increased the interest rate at a faster pace vs the RBI which narrowed the interest rate differential. This brought down the premium to as low as 1.70% at one point, which spooked the carry traders and they started to unwind the short USD position. 

Currently, the US Inflation is thrice the Fed’s target of 2%, and in India, the inflation is a tad bit higher than the RBI’s 4-6% target band which might give space to RBI to pause earlier than the Fed. This may further narrow down the interest rate differential. However, due to increased uncertainty over the interest rate cycle, the premiums could be volatile in FY 2023-24 and yields would be under pressure, further making the USD selling less lucrative for the carry traders.

Outlook on the rupee for Q1FY2024

So far, the USDINR kept oscillating between 81.50-83.00 levels and the dips have been aggressively bought. As liquidity has tightened, RBI recently injected Rs 1 trillion, which showed the Indian banking system is facing a liquidity crunch and it could push the central bank to mop the surplus USD. Further, after long consolidation, Crude oil prices have given a breakout and could move to $90-95 levels, which brings back the worry of rising CAD. In a nutshell, the USDINR has strong support around the 81.50-81.80 zone. There is a 70% probability that it will bounce back to 82.70-83.00 in the near-term based on above mentioned factors. If it manages to break the all-time high of 83.25, then one can expect the spot will move towards 84-84.50 levels by the end of Q1 2024.

(Amit Pabari, MD, CR Forex. Views expressed are author’s own. Please consult your financial advisor before investing.)

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