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The repo rate hike can help portfolio flows into the country, thus helping the currency.
Measures taken prior to the policy such as opening an FCNR (B) swap window, increasing the limits on banks to raise overseas loans, and the swap window for oil marketing companies have helped the rupeeappreciate from 68.8 to 62 against the dollar.
Stemming outflows
The monetary policy takes these measures forward with the hike in repo rate to 7.50 per cent. This could translate into higher bond yields and attract foreign investors to Indian debt instruments. Other emerging markets such as Indonesia, Brazil and Turkey have already resorted to rate hikes in the last six months to control currency volatility and inflation.
Sujoy Das, Head-Fixed Income, Religare Invesco Asset Management says, “Interest rate differentials between India and US remain quite high and there have been many policy changes, making it easier for FIIs to buy Indian bonds; for instance, the auction mechanism was discontinued. If the currency continues to show stability, we should be able to attract flows.”
Another theme running in the background is to boost foreign exchange reserves before the Federal Reserve starts tapering. India has already lost over $10 billion from the debt market and $1.6 billion out of equity since Fed Chairman Ben Bernanke announced his intention to start tapering. The rupee was trading at 55.3 before the Fed-tapering pandemonium began in May.
As the monetary policy statement says, ‘tapering is inevitable’.
But once that happens, how are we positioned to protect the rupee? Not too well since forex reserves - the principal arsenal of the central bank - have depleted sharply in recent times. Recent foreign fund outflows and central bank interventions in the currency market have reduced reserves to $274.8 billion.
Import cover
The import cover provided by forex reserves has currently depleted to around seven months of imports. To be taken to a safer nine month-import cover, the reserves need to increase by another $100 billion. Depleting forex reserves not only limit the central bank’s ability to control currency volatility, but also embolden currency speculators.
The measures taken prior to the policy, along with the potential portfolio inflows, can repair the damage to forex reserves, somewhat.
The calibrated reduction in marginal standing facility (MSF) rate by 75 basis points and retaining the restrictions enforced to curb currency speculation, such as — ban on banks trading on their proprietary accounts in currency futures, increase in margins on exchange-traded currency futures and the limits on overnight position of banks in currency forwards — implies that RBI is not yet ready to give a free rein to the rupee traders.
If further erosion in the rupee is contained and the central bank is able to bolster its reserves in the breathing space that the Federal Reserve has provided, it will be better prepared to face the QE tapering, when it actually happens.
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