For most of this year, the Reserve Bank of India has limited exchange gains as global investors invested around $ 50 billion in stocks and shares in companies. This has driven liquidity in rupees in a banking system that is already full of cash from RBIstimulus measures.
There is a growing consensus among traders and fund managers that mounting pressures, particularly excess liquidity distorting money markets, may prompt the central bank to consider a number of changes, from relaxing its control over the currency. Asia’s worst performer to lower bond purchases.
A modest gain of the rupee over the past month could mean that Political leaders they are already cutting back on intervention a bit, or that tickets are starting to get the best of them.
“We believe that the RBI faces a difficult task of liquidity management as it juggles foreign exchange inflows, purchases in the secondary bond market to keep long-term borrowing costs low and ensure that market rates are aligned with the policy rate, “said Kanika Pasricha, an economist at Standard Chartered Plc in Mumbai. Steps should be taken to realign money market rates with policy rates, he said.
While most Asian currencies have benefited from a weaker dollar, the rupee is down 3% this year. Traders point to how the RBI has bought $ 58 billion in the first nine months of the year as signs of its intervention.
Governor Shaktikanta das He has only commented very broadly on the matter, writing in the most recent policy statement that the central bank acts to cushion currency volatility and keep the rupee in sync with underlying national fundamentals.
Inflows into India’s equity markets have risen to more than $ 20 billion this year, the highest annual amount since 2012. Foreign investors have also completed about $ 30 billion in cash acquisitions, according to data compiled by Bloomberg.
Declines in the dollar, which is forecast to continue falling in 2021, are driving cash flows to emerging markets globally.
In India, capital inflows can reach $ 82 billion by the end of the fiscal year through March, and then continue at the same pace for the next 12 months, according to estimates by Deutsche Bank AG.
“Given the multiple challenges of excess liquidity due to capital inflows and inflation, the RBI may be forced to reduce intervention and allow appreciation,” said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt.
The median of estimates compiled by Bloomberg is for the rupee to appreciate to 72 to the dollar by the end of 2021. Analysts at Goldman Sachs Group Inc predicted the currency would hit 70 in March 2022. It was trading down 0, 1% to 73.6125 on Tuesday. .
To be sure, some, including B Prasanna, director of global markets, sales, trade and research at ICICI Bank Ltd, argue that when looking at the rupee relative to a basket of its trading partners, the currency is overvalued and the RBI will have little tolerance to drastically strengthen.
With excess cash in the banking system estimated at nearly Rs 7 lakh crore ($ 95 billion), key overnight rates have plunged below the reverse repurchase rate that marks the lower bound of the policy corridor of the central bank.
Shorter lower rates without a similar drop in long-term borrowing costs means a steeper yield curve, which tends to undermine efforts to boost growth.
The price also points to loan rates falling below similar-term bond yields, limiting banks’ profits. If things stay that way long enough, it would also cause a mismatch between assets and liabilities in the financial sector, which could affect the economy as a whole.
Analysts suggest that the RBI will be forced to address the glut in early 2021.
Among a host of options, it could allow wider access to the reverse buyback window, hold variable reverse buyback auctions at higher rates, and establish a permanent deposit facility to soak up excess liquidity, according to economists at HSBC Holdings Plc. , including Pranjul Bhandari.
Other possibilities are to increase the cash reserve rate and choose not to replenish currency that is leaking from circulation, they wrote in a recent note.
But there is also the fear that taking these kinds of actions could end up scaring the debt markets and eroding demand for government bonds.
This would be a huge problem with the government selling record amounts of bonds to help the nation overcome the coronavirus pandemic.
Against this broader backdrop, this month the central bank reminded markets of its ability to deliver surprises.
While the RBI kept rates unchanged as expected at its final policy meeting this year on December 4, it shattered expectations among traders and fund managers that it was ready to start absorbing excess liquidity.
Michael Patra, the influential deputy governor in charge of monetary policy, said this month that the RBI is monitoring “the liquidity situation very closely” and is aware that excess funds in the system can fuel inflation.
The next monetary policy decision is scheduled for February 5, at which time market pressures may be even greater.
“The options for the RBI to manage and accelerate the recovery are a complex balance of alternatives involving economic and financial trade-offs,” said Saugata Bhattacharya, chief economist at Axis Bank Ltd in Mumbai. “A variety of tools will be implemented incrementally to gradually drain liquidity from the system and tighten financial market conditions.”
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