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MUMBAI: The Reserve Bank of India (RBI) appears to have stopped trying to control the rupee to help exports, leaving the coin drift to a maximum of six months and raising expectations that it will continue to win, analysts and market participants said.
RBI intervention in dollar purchases in recent months has made the rupee one of the worst performing Asian currencies in 2020, despite massive inflows of dollars in equity markets and for corporate fundraising .
The RBI has kept the rupee weak to help exporters and made large interest rate cuts to support the economy as the coronavirus pandemic slows activity, but inflation risks are now putting it in a bind.
The government’s decision to dramatically increase market borrowing while the economy and public finances are under pressure is increasing bond yields, which move in reverse of prices.
Dollar weakness foreign direct investment meanwhile, stock market inflows have added to the strength of the rupee.
Traders and analysts say that while the central bank may step in to cut yields, it doesn’t have much room to restrain the rupee without fueling inflation at a later time.
“I think it is very tactical. For now, yes, the RBI is happy to allow some appreciation, as it is running out of room for an unsterilized intervention, ”said A Prasanna, chief economist at ICICI’s Primary Securities Concessionaire.
The RBI generally removes the excess supply of rupees in the banking system from its foreign exchange interventions by selling bonds.
In recent months, however, the RBI has been unable to sell bonds on the open market and instead bought them to combat rising yields.
It has been using a strategy inspired by the US Federal Reserve’s “Operation Twist” program: buying long-term debt and selling short-term debt to manage market returns and support the government’s record borrowing plans.
Bonds above the rupee for now?
The RBI may become increasingly constrained by intervening in the rupee, particularly if there is a need to support bond markets through buying, Nomura analysts wrote in a note.
The recent rise in retail inflation, reflecting supply bottlenecks due to the lockdown, adds to the RBI’s woes.
Announcing market stability measures on Monday, the RBI said the recent appreciation of the rupee should help contain imported inflationary pressures.
“I doubt that the appreciation will have an impact on inflation, but it is a good hedge for the RBI to maintain a hands-free approach to the currency market,” said Prasanna of ICICI PD.
Traders are happy with the change in RBI’s currency management strategy and said the rupee will catch up with its regional peers and benefit from the weakness and overall dollar inflows. However, they are not sure whether the RBI is likely to be left out entirely.
Some believe the RBI may continue to intervene in the futures market to indirectly influence spot levels, while others say it will continue to want to create foreign exchange reserves.
DBS Bank said it sees room for the dollar to stabilize after the notable correction since March, and therefore beyond the flow-driven gain in the rupee, a strong and persistent one-sided bias might not be in play.
“We believe that the rupee will continue to appreciate. With intervention at the lower end, we could see a 72-74 range in the rupee for the next 3-6 months, “said Sameer Narang, chief economist at Bank of Baroda.
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