Rupee breaks 81, policy challenge: let it find its value or set forex on fire, hike rates

Whom The rupee crossed the 81 mark against the US dollar On Friday, policymakers in New Delhi were left with a dilemma as the Reserve Bank of India (RBI) burned through forex reserves at a dramatic pace this calendar year to curb exchange rate volatility – an intervention many in the market believed to be an intervention. to defend the currency at a certain level.

In just eight months from mid-January to mid-September this year, foreign exchange reserves were depleted by about $90 billion, or an average of $11 billion per month. For the week ended September 16, India’s foreign exchange reserves stood at $545.65 billion, compared to $634.97 billion in the week ended January 14.

“How much?” asked the CEO of a foreign institutional investor (FII) on condition of anonymity. While persistently high inflation of 7 percent plus has prompted the RBI to hike policy rates, the government is poised to maintain GDP growth and create more jobs as several major states go to polls in the next 12-18 months.

With several agencies cutting their GDP growth forecast to 7 percent and below, the Union finance ministry is in a quandary over whether aggressive monetary tightening is the right strategy for India, which is facing challenges that may require a different response from western countries. . In this context, Finance Minister Nirmala Sitharaman has already said that “the RBI may not be as synchronized as the western countries would be” – in other words, raising policy rates may not be the best thing for India.

he explained

A bumpy road ahead

With elections due in more than a dozen states in the next 12-18 months, the imperatives of GROWTH and the need for job creation are weighing heavily on the government’s mind. Instead of steep interest rate hikes to curb inflation, policymakers will let the rupee depreciate.

Policymakers in the government as well as the RBI are convinced that most of the inflation is ‘imported’. They debate the relative merits and demerits of an “overt” move such as a rate hike versus a “stealth” gradual depreciation of the rupee. “Letting the rupee find its level is a better tool to curb demand, as opposed to monetary tightening through interest rate hikes, which is like using a sledgehammer,” said an official on condition of anonymity. A depreciating rupee makes imports more expensive and curbs demand.

A depreciating rupee makes imports more expensive and reduces demand.

According to the RBI’s April 2022 monetary policy report, a 5 percent depreciation of the rupee could result in a 20 basis point increase in inflation and a 15 basis point increase in GDP growth. In 2022, the rupee depreciated by 8.2 percent against the US dollar. Politicians in New Delhi are mulling over the idea that the RBI should not have any sacrosanct level. “This (gradual weakening of the rupee) covert measure is better than an overt monetary policy move of a rate hike,” said the politician, who did not want to be named.

“Even today the rupee closed above 81,” said a senior executive at FII, hinting at the central bank’s refusal to allow the rupee to slide. The Indian rupee breached the 81 threshold against the US dollar for the first time on Friday to settle at 80.98 as the dollar continued to strengthen against all other major currencies following the Federal Reserve’s aggressive rate hike announcement.

The rupee lost 1.5 percent in the two days following the Fed’s announcement on Wednesday.

It opened at a record low of 81.03 against the US dollar, compared to the previous close of 80.86. The national currency fell to a minimum level of 81.22 per US dollar during the day. The rupee’s weakness also dampened investor sentiment in the equity market, with the benchmark Sensex on the BSE ending a sharp decline of 1,020 points, or 1.7 percent, at 58,098.9. On the NSE, the broader Nifty lost 302.45 points, or 1.7 points, to close at 17,327.3 on Friday. The two indices lost more than 2.2 percent in the last two trading sessions.

The house is already divided over the quantum and pace of rate hikes by the RBI. There are early but visible signs of disagreement between the government and the central bank over the latter’s monetary policy to check inflation and the former’s imperative to revive growth. The three-day RBI monetary policy committee is scheduled to begin on September 28 and announce the move on September 30.

It is learned that the Northern Bloc is leaning towards a good pace of rate hike by the RBI rather than an aggressive stance taken by central banks of developed countries as inflation is largely driven by global factors and other concerns related to employment and sluggish investment. prevails over inflation.

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