NEW DELHI: The Indian rupee is back in the spotlight. Even as the currency noted a 1 per cent appreciation against the US dollar to end near 73.3, speculation is rife that the gains may be short-lived amidst a sharp rise in Covid-19 cases. The trajectory of the rupee may also make it tougher for the Reserve Bank of India’s (RBI) Monetary Policy Committee to do its job of balancing the trade-off between growth and inflation, believe analysts at SBI Research.
One of the factors that is supporting the rupee is the RBI’s interventions. “Given the prospects of higher domestic inflation, as supply disruptions mount, it is not doing any harm for RBI to lean with the wind and let rupee appreciate as it is reducing imported inflation when metal prices are rising, and clearing the liquidity overhang to some extent,” the analysts noted. In fact, the large supply of dollars will ensure that the rupee will appreciate and could potentially play to the RBI’s advantage in inflation management.
However, to neutralise any additional liquidity, the central bank is also intervening in the forward markets through swaps—selling the dollars to buy it back at a future date and paying a premium. The RBI has turned into a net buyer of dollar forward contracts and its outstanding position was $47.3 billion in January 2021.But, herein lies a future challenge. While a rising forwards premia is a signal for carry traders to pour in more money, a vibrant non-deliverable forwards market and a high forward premia can put significant depreciating pressure on the rupee. “There could be limits to sterilised intervention and rise in forward premia beyond a threshold level. It may be noted that a high premia also deters importers from hedging their dollar positions,” the analysts wrote.
Meanwhile, an appreciating currency when growth is a priority is not what the central bank is looking for, since it may hamper growth.“India is currently only in the initial phase of vaccination.., while the growth outlook of the US, UK and even European Union remains strong. In that case, if capital flows reverse, the exchange rate could start depreciating and inflationary pressures will mount further, thus complicating the task of RBI’s MPC,” they warned.