The Reserve Bank of India has intensified its efforts to support the rupee, aided by an increase in its foreign exchange reserves, which allows it to counter pressure caused by rising oil prices.
According to a source familiar with the matter, the Reserve Bank of India (RBI) decided to shift to a more stable intervention regime to support the national currency over the past month. Previously, the bank intervened primarily to curb sharp exchange rate fluctuations. This tactical shift was made possible by the inflow of fresh funds amounting to $73 billion under RBI's dollar attraction measures since June.
In one instance, the RBI spent $7 billion in a single day, conducting interventions in both domestic and foreign markets when the rupee approached a historic low. Signs indicate that this strategy has led to greater stability, as short-term currency volatility has decreased almost to its 10-month low.
Additional funds strengthen the RBI's position at a time when pressure on the currency—which is the least successful in Asia this quarter—is increasing again. The easing situation in June is weakening due to rising crude oil prices, which increases the current account deficit, as well as due to the narrowing interest rate differential with the US, which pulls capital out of Indian markets.
A question arises whether the intensified efforts will be sufficient, given that over $700 billion in reserves have failed to convince investors of the rupee's undervaluation. Chandresh Jain, a strategist for emerging markets and currency operations at BNP Paribas SA, noted that 'the RBI's main goal is to mitigate volatility and the speed of movements in any direction, not to fundamentally change the trajectory.' He added that 'with the support of new inflows, the RBI has the ability to maintain this position for some time.'
The volatility of the dollar against the rupee fell by approximately 100 basis points this month, compared to a drop of six basis points in the global currency index. This surprised market observers accustomed to more significant currency fluctuations under the management of RBI Governor Sanjaya Mahlotra.
Rajeshwari Sengupta, an associate professor at Indira Gandhi Institute of Development, suggested that under Mahlotra's leadership, who succeeded a predecessor aiming to stabilize the rupee by the end of his term, 'it might mean a slight weakening.' An RBI representative did not respond to the request for comment.
The change in the intervention model slowed the depreciation of the rupee but could not reverse its trend. For the current quarter, the currency weakened by 0.8% against the dollar, contrasting with a 5.2% drop from January to March, when investor sentiment towards the fuel-importing country worsened due to the Middle East war.
Demand for dollars from importers remains tight as they hedge future purchases to protect against rupee depreciation. According to data from Clearing Corp. of India, used as an indicator of hedging by importers and exporters, average monthly forward dollar purchases this year increased by 40%, reaching $60 billion. Conversely, dollar sales increased by 27%, totaling $32 billion.
Ashish Vaidya, Head of Treasury at DBS Bank Ltd. in Mumbai, stated that 'the issue of persistent demand for dollars from importers and insufficient dollar sales from exporters needs to be addressed.' He advised: 'An increase in forward premiums driven by higher interest rates is necessary to correct this situation.'
This highlights the delicate balance the RBI must maintain, weighing economic growth against currency defense. Unlike many of its peers, the central bank is currently refraining from raising rates, as this could slow down an economy facing difficulties due to the war with Iran.
Another variable is how the RBI will manage its future obligations to sell over $100 billion worth of dollars. Recent inflows allow the bank to let some short-term short-dollar positions mature without depleting too much banking system liquidity. This occurs because creditors exchange the dollars they receive for rupees through the central bank's preferential mechanism.
Abhishek Upadhyay, an economist at ICICI Securities Primary Dealership, believes that 'it is important for the RBI to set a clear boundary for the rupee in the near term, as there is a risk that further rupee depreciation could become a self-fulfilling prophecy.'