Clipped from: https://www.thehindubusinessline.com/opinion/editorial/rupee-worries/article69057945.ece
RBI should review strategy on containing rupee volatility
The rupee has been creating headlines in recent weeks, recording lifetime lows every other day. This is, however, not as alarming as it sounds; the Indian currency is down only 2.68 per cent against the dollar in 2024. The RBI has been fairly successful in allowing the Indian currency to move in an orderly manner over the last decade. The compounded annual depreciation in the rupee is 3 per cent between 2015 and 2024. But the rupee has recorded losses in nine out of the last ten years, implying that the central bank is comfortable about allowing the rupee to depreciate.
The RBI should review the tools it deploys to control undue volatility in the Indian currency; forward positions in the rupee have been contributing to the volatility in recent weeks. The rupee traded flat in the first three quarters of 2024 with the declining trend beginning since October. All emerging market currencies were hit by the surge in dollar in the last quarter of 2024, on US optimism over Donald Trump becoming the President. A sharp increase in foreign portfolio outflows in October and November, expansion in trade deficit and high inflation numbers also added to the pressure on the rupee in recent months. Yet, the rupee has fared well compared with most other emerging market currencies including the Brazilian Real (down 20 per cent), the Mexican Peso (18 per cent) and the South Korean Won (11.6 per cent) against the greenback in 2024. RBI’s active intervention in the forex market seems to have helped rupee record lower depreciation vis-a-vis its emerging market peers.
The central bank has been using a variety of tools, including intervention in the interbank OTC market through large PSU banks, positions in domestic and overseas forward market, and through domestic exchange traded derivatives, to manage the rupee. With intervention in the OTC market depleting forex reserves and reducing domestic liquidity, the RBI has been taking large positions in the forwards market in the last quarter of 2024. Outstanding short positions of RBI in the forward market jumped to $49.1 billion towards October-end, registering an increase of 237 per cent over net short positions towards the end of September 2024. A short position in dollars implies that the RBI will have to buy dollars in the future, which will apply downward pressure on the rupee. According to media reports, the central bank had decided not to roll over some of these positions in December, contributing to the turbulence in rupee in the last week of December.
The RBI is surely aware that positions in the forward market are highly risky and can cause large losses, if judgement of the currency movement proves erroneous. The central bank also needs to examine whether it should allow the currency to appreciate when conditions are favourable. This can help control imported inflation and reduce the liabilities of companies which have borrowed in overseas markets.
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