The RBI finally came out guns blazing to defend the weakening rupee. The sweeping measures announced during the weekend—an attempt to curb speculative trading, manage dollar demand and reduce volatility in the foreign exchange market—were some of the most aggressive moves seen since 2013. Incidentally, the measures came just when Robert E Hall and Michael Woodford were awarded the Nobel Prize in economics for their macroeconomic stabilisation models that aim to help central banks and governments manage booms, recessions and shocks. Following the RBI announcement, the rupee surged more than 1 percent on Monday, pulling away from the key 97 level against the dollar and further rallied 82 paise to reach 94.96 in early trading on Tuesday. Analysts expect the Indian currency to gain ground and stabilise in the 93-94 range provided there are no unexpected macroeconomic shocks.
One of the measures is a special window that reduces the need for State-run oil marketing companies to purchase dollars directly from the spot market. While the move is expected to reduce volatility in dollar demand, analysts believe it could deplete forex reserves. The RBI also tightened hedging rules to manage currency market pressures besides introducing a forex risk reserve for lenders of a certain value for the first time.
In all, the currency is down 6 percent so far this year, although Governor Sanjay Malhotra maintains that the rupee is undervalued. As the rupee depreciated in recent weeks, the central bank exhausted $43 billion of the $143 billion raised via a special deposit window and borrowings under a swap facility during August. But the central bank’s dollar sales failed to lift the sentiment, with the rupee settling at 96.73 last Friday, with the one-year forward racing past 100.
Perhaps this prompted the RBI to go all-out. Though the measures helped the rupee recover nearly 2 percent in two days, sustained stability will depend on the steadiness of crude oil prices, global bond yields and foreign capital flows. The biggest factors piling pressure on the Indian currency are surging crude prices and capital outflows that resumed in September. If the Brent benchmark remains above $100 for longer, the RBI would need to deploy other policy tools to defend the rupee. But they too would be stop-gap measures until India’s trade deficit undergoes a meaningful correction.
