Rupee breaks above 81, policy challenge: let it find its value or burn forex, hike rates

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As the the rupee broke the 81 mark against the US dollar Intraday Friday, policymakers in New Delhi face a dilemma, with the Reserve Bank of India (RBI) burning foreign exchange reserves at a blistering pace this calendar year to prevent exchange rate volatility – an intervention that many in the market think is to defend the currency at some level.

In just eight months between mid-January and mid-September this year, foreign exchange reserves were depleted by nearly $90 billion, or about $11 billion on average per month. For the weekend of September 16, India’s foreign exchange reserves stood at $545.65 billion, compared to $634.97 billion on the weekend of January 14.

“How long?” asked the CEO of a foreign institutional investor (FII), who declined to be named. While sustained high inflation of over 7% prompted the RBI to raise policy rates, the government is keen to preserve GDP growth and create more jobs as several major states head to the polls in over the next 12 to 18 months.

As several agencies cut GDP growth forecasts to 7% and below, the Union Finance Ministry questions whether an aggressive tightening of monetary policy is the right strategy for India, which faces challenges which may require a different response than Western countries. . In this context, Finance Minister Nirmala Sitharaman has already stated that “the RBI may not be as synchronized as Western countries would be” – in other words, the rise in key rates may not be not be the best thing for India.

Explain

Bumpy road ahead

The imperatives of GROWTH and the need to create jobs are heavy on the government’s mind with elections in more than a dozen states over the next 12-18 months. Instead of big rate hikes to contain inflation, policymakers prefer to let the rupee depreciate.

Government politicians as well as the RBI are convinced that much of the inflation is ‘imported’. They discuss the relative advantages and disadvantages of “overt” action such as an interest rate hike versus a “secret” gradual depreciation of the rupee. “Unlike monetary tightening through rate hikes, which is akin to wielding a hammer, letting the rupee recover to its level is a better tool to curb demand,” said one official, who did not wished to be appointed. A depreciating rupee makes imports more expensive and dampens demand.

A depreciating rupee makes imports more expensive and dampens demand.

According to the RBI’s April 2022 monetary policy report, a 5% depreciation of the rupiah could cause inflation to rise by 20 basis points while GDP growth could be 15 basis points higher. . In 2022 so far, the Rupee has depreciated by 8.2% in 2022 against the US Dollar. Policy makers in New Delhi seem to be moving away from the idea that the RBI should not hold any particular sacrosanct level. “This covert measure (of gradually weakening the rupee) is better than an overt monetary policy action of raising rates,” said a politician who did not wish to be named.

“Even today the rupee closed above 81,” said a senior FII executive, underscoring the central bank’s aversion to letting the rupee slide. The Indian rupee broke through 81 against the US dollar for the first time on Friday, before settling at 80.98, as the greenback continued to strengthen against all other major currencies following an aggressive rate hike announcement by the Federal Reserve.

In the two days since the Fed’s announcement on Wednesday, the rupiah has lost 1.5%.

It opened at a record high of 81.03 against the US Dollar, compared to the previous close of 80.86. The national currency fell to an intraday low of 81.22 per US dollar. Weakness in the rupee also dampened investor sentiment in equity markets and the benchmark Sensex index at BSE fell sharply by 1020 points or 1.7% to close at 58,098.9. The wider Nifty at NSE fell 302.45 points or 1.7 on Friday to close at 17,327.3. Over the past two trading sessions, both indices have lost more than 2.2%.

The house is already divided on the quantum and pace of rate hikes by the RBI. There are early but noticeable signs of a divergence of views between the government and the central bank on the latter’s monetary action to control inflation versus the former’s imperative to revive growth. The RBI’s three-day monetary policy committee is scheduled to start on September 28 with action to be announced on September 30.

It is learned that North Block is leaning towards a benign pace of rate hikes by the RBI rather than the aggressive stance taken by central banks in developed countries, as inflation is seen to be driven primarily by global factors and other concerns about employment and the slow pace of investment. priority over inflation.

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