Informist, Friday, Apr 5, 2024
By Pratiksha and Kabir Sharma
MUMBAI – The currency market rarely has any takeaway from the Monetary Policy Committee meeting outcome, but this time around, it seems like it has a major one.
The conversations around the Indian currency did not change even when it hit the record low in the past few trading sessions. Market players continued to expect that the rupee will appreciate in the medium term, mainly on account of inclusion of Indian government bonds into JP Morgan's Government Bond Index – Emerging Markets suite starting on Jun 28.
However, with Reserve Bank of India Governor Shaktikanta Das today going out of his way to say the central bank will remain committed to ensuring substantial foreign exchange reserves, market participants do not expect significant appreciation in the Indian currency going ahead.
"We had built a strong umbrella and we were using it because it was raining heavily. Now the reserves have risen again," Das said. "This is one area where the Reserve Bank stays committed to ensure that exchange rate of rupee is market determined but it is our prime focus to build up a strong umbrella, a strong buffer in the form of forex buffers for when the cycle turns or for when it rains heavily," Das said.
Earlier, market participants were expecting the rupee to be in a range of 82.00-82.50 a dollar in the near term, but now they expect the Indian unit to trade in 82.80-83.50.
Market players have tried to put a finger on all the plausible reasons behind the RBI being hell-bent on building forex buffer at a time when its foreign exchange reserves are already at an all-time high of $645.6 bln as of Mar 29.
The primary reason seems to be the central bank wanting to be well-prepared for the external risk India is exposed to once the bond index inclusion happens, according to market participants. When the scale of inflows rises, so does the potential magnitude of outflows, for which the RBI will want to be prepared, they said.
"If you just look at the reserves build up, it is not just the absolute reserves that matter but also the quality of reserves. So what are the incremental reserves that are being built on?" said Abheek Barua, chief economist, HDFC Bank.
"Except for the last couple of months, FPI has been absent or it’s a very-very small number, so I think, at the back of RBI's mind there is this issue that against the FX reserve, there are potentially volatile short-term claims, which could just reverse very quickly as this includes hot money which has come to the equity market, from the bond inflows and it could reverse."
Indian government bonds’ inclusion into JP Morgan's Government Bond Index – Emerging Markets will result in inflows of over $25 bln. Bloomberg will add India's government bonds to the Bloomberg Emerging Market Local Currency Index and related indices starting Jan 31, resulting in almost $3 bln of inflows.
Earlier in March, the governor had said that the central bank will be able to handle the kind of inflows or outflows emanating from the index inclusion, owing to the strong foreign exchange reserves. In March, Informist had reported citing dealers that at the Foreign Exchange Dealers Association of India annual conference held in London, RBI officials said that the central bank was looking to beef up its foreign exchange reserves because of India's inclusion in global bond indices.
"My view is that as financial account becomes more open and capital markets deepen, the RBI will prefer higher reserves as a cushion against external shocks. So yes, I expect FX reserves to trend higher,” said Dhiraj Nim, FX strategist, ANZ Banking Group.
Market participants said that with the inclusion of Indian government bonds into several global indices, having large forex reserves will not be just a 'good to have' but a 'necessity' for the central bank, as any big risk-off episode will lead to huge chunk of outflows. "It is possible that if the flows intensify, there will be more interventions," Barua said.
Market players also pointed out that together, the RBI’s domestic spot and forward outstanding book is currently way off its record high of $692 bln, touched in September 2021. This also indicates that the RBI has more room to accumulate the greenback. The RBI's keenness to build forex buffers may also be on account of geopolitical uncertainties, as per market players.
"It's not just to do with bond inclusion. Bond inclusion definitely creates one source of potential risk, but in general, the geopolitical risks have only gone up and in this kind of environment there may be sudden instances of volatility which you may not completely anticipate," said Neeraj Gambhir, group executive – treasury, markets and wholesale banking products at Axis Bank. "Therefore, for a large economy like India, it makes sense to make sure that we have reserves which are significant."
After recovering from the COVID-19 pandemic which sent all financial planning for a toss, financial markets across the globe were jolted by Russia's invasion of Ukraine. Last year, a war between Israel and Palestine-based militant group Hamas in West Asia, which is still underway, came as a shock out of nowhere.
"I am not buying into this business of rupee being on-a long-term appreciation part at all. I think over the next year, yes, there would be appreciation pressure but the RBI will buy dollars to sterilise the rupee liquidity that is created through some measures. Maybe we will see some measures if the flows are indeed very strong," Barua said.
The RBI’s resolve to build reserves will also help it to keep the export competitiveness of the Indian currency in check, traders pointed out.
The RBI seems to have strong reasons to build its forex arsenal, and consequently keep the Indian currency from appreciating, and if one looks at how Mint Street managed the currency last year, it appears entirely certain that exchange rate stability will be at the heart of its intervention strategy this year as well. End
US$1 = 83.30 rupees
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