RBI’s aggressive forex intervention and the way forward
The Centre struck a rich vein last week with the RBI transferring a larger-than-expected dividend of nearly Rs 1 lakh crore. This was more than double the government had budgeted, and given the bleak revenue collections, it sweetens the prospective stimulus pot.
The unexpected bounty was a result of the RBI's aggressive selling of foreign currency, with gains shooting up by an unprecedented 69 per cent in FY21.
Between July 2020 and March 2021, it sold USD 85 billion worth dollars as against $20 billion last year. Of this, USD 62 billion worth was sold during the last three months of FY21, which only makes one notice how the RBI went out of its way to rescue the Centre's strained finances.
The RBI was also a net forex buyer in FY21, having bought a net $88 billion in the spot market, making the rupee the worst performer among Asian currencies and placing India on the US Treasury’s watch list for currency manipulation.
Foreign assets grew by 11.5 per cent last fiscal, but any additional growth won't come without implications. With banks depositing excess liquidity back with the RBI under the reverse repo window, the central bank's key policy tool - repo rate - is rendered ineffective to support the economy and counter the threat of rising inflation.
So some believe the RBI’s aggressive forex intervention helped manage yields and price rise in the short-term. By the central bank’s own admission, rupee appreciation last year helped contain imported inflationary pressure as it lowered the oil import bill, besides others.
So, should the RBI continue going to the forex market with an open hat? Certainly not, as such forex-led higher dividend compels it to face the trilemma of managing balance sheet expansion, bond yields and rupee volatility.
While it may have eased pressure on government finances this fiscal, it downsized the RBI's economic capital to 21.7 per cent of total assets from a high of 26.7 per cent seen last year. Going ahead, the central bank has to cleverly balance bond purchases and forex assets without affecting yields and rupee appreciation, which could be counterintuitive and further lower its economic capital.