The broad and persistent U.S. dollar rally that is causing the rupee to depreciate in line with what is happening globally is being driven by the Federal Reserve's aggressive monetary tightening and the ensuing scramble by investors to sell riskier assets in favour of dollars.
Digital
Desk: A senior source familiar with the central
bank's thinking claims that the Indian central bank is prepared to sell a sixth
of its foreign exchange holdings in order to prevent a sharp decline in the
value of the rupee after it recently hit record lows.
The source claimed that the fall would have been much greater if
the Reserve Bank of India (RBI) had not intervened to stop the slide on
Tuesday, when the rupee weakened past the psychological level of 80 against the
dollar and lost more than 7% of its value in 2022.
The RBI's foreign exchange reserves have dropped by more than $60
billion since peaking at $642.450 billion in early September, primarily as a
result of dollar selling intervention but also as a result of changes in
valuation.
Despite the drawdown, the RBI's $580 billion in reserves, which
place it fifth in the world, give the central bank assurance that it can halt
any jerky, sudden depreciation of the currency.
"They have shown that they will use reserves if necessary to
reduce rupee volatility. They've demonstrated a willingness to use the
resources they do have "the source stated.
The source continued, "The RBI can afford to spend even $100
billion more if necessary to defend the rupee."
The source claims that the RBI will take action to stop any
excessive currency depreciation rather than attempting to safeguard the rupee
or maintain it at a particular level.
The RBI did not immediately respond to a request for comment.
The broad and persistent U.S. dollar rally that is causing the
rupee to depreciate in line with what is happening globally is being driven by
the Federal Reserve's aggressive monetary tightening and the ensuing scramble
by investors to sell riskier assets in favour of dollars.
India's trade and current account deficits seem doomed to get
worse given the rise in commodity prices, particularly oil, which makes up a
significant portion of India's import bill as a result of the conflict in
Russia and Ukraine.
"There is no doubt
that a sizable portion of the rupee decline is related to the U.S. dollar
strength and higher oil prices, but the RBI has also been behind the curve
despite inflation remaining above the midpoint target for almost three years at
this point and growth momentum still strong. "India's macro fundamentals
remain strong and that means this trend could reverse as the dollar
peaks," claims Charu Chanana, a markets strategist at Saxo Capital
Markets.
Since January, the monthly trade deficit has averaged $25 billion,
which suggests that a $100 billion intervention fund to directly offset the
demand for dollars would last just four months. Foreign investors have sold
nearly $30 billion worth of shares so far in 2022.
The majority of analysts and traders think the rupee's worst days
are still ahead of it, despite the Reserve Bank of India's (RBI) intention to
defend the currency and India's strong macroeconomic fundamentals.
According to a senior trader based in Singapore, it is highly
unlikely that foreign portfolio investors will quickly return to India given
the current global scenario of rate increases and quantitative tightening.
"The absorbing of dollar liquidity has only just begun."
After a series of moves by the government and the central bank,
authorities are hopeful that foreign investors will return to the market in the
following month or so. However, investors are still wary.
"The United States has recently begun to tighten its monetary
policy, which would cause dollars to leave India. I would engage in a trade for
long dollars. The rupee must exceed its fair value. With ease, we can reach 84
to 85 before the market turns "Added a second trader.
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