RBI must not upset growth pace while managing Rupee rout
The Indian rupee fell to a heart-sinking low of 81 against the dollar on Friday, forcing analysts to warn the exchange rate’s run towards 82. The US Federal Reserve (Fed) rate hike that sent the dollar to a 20-year high and the rupee to an all-time low drives the current rout. The RBI is expected to sell dollars and alleviate the depreciating pressure on the rupee. The central bank has been at it since the start of 2022, when the dollar-euro pair put relentless pressure on all currencies, particularly emerging markets. While Governor Shaktikanta Das maintained the RBI doesn’t target a particular level for the rupee, he assured markets of ‘zero tolerance’ against the rupee’s volatile and bumpy movements. The government, too, isn’t apprehensive about the weakening rupee seeing global market dynamics as a stabiliser of import and export disparity.
So far, the RBI has spent nearly $90 billion, reducing forex reserves from $642 billion to about $550 billion, translating to nine months of import cover as against 16 months. The war chest was put in place precisely to counter tough times, but unlike China or Japan, whose reserves are built on trade surpluses, ours were built on foreign capital inflows, often accumulated when the Fed cuts rates (like last year), and depleted during rate hikes (like now). The rupee has already lost nearly 7% against the dollar and is facing pressure due to inflation, widening current account deficit, geopolitical events and tightening liquidity conditions. While persistent high inflation weakens the rupee, hurting growth and export competitiveness, capital flows and associated exchange rate fluctuations affect macroeconomic and financial stability.
It’s also essential to understand that the rupee breaching past 81 against the dollar is the nominal exchange rate. Even if we acknowledge the dollar’s dominance, the fair value and external competitiveness of the Indian currency are best determined using the real effective exchange rate pegged to a basket of 40 currencies. Currently, it shows the rupee as overvalued by at least 5–5.5%, indicating room for further depreciation. Das is confident that India’s underlying fundamentals ‘are strong and resilient’ with foreign exchange reserves ‘adequate’. Yet, the RBI finds itself in a dreadful monetary policy trilemma of simultaneously managing the rupee rout, capital flows and inflation without upsetting growth.