RBI will continue with its aggressive dollar buying

The rupee closed at 75.68 against the dollar on March 31, 2020 when the Covid-19 pandemic had just started spreading in the country. The reserves in November 2019 were hovering at $448 billion and by March-2020 they were up at $478 billion.

Due to the pandemic the rupee weakened and in April -2020 had peaked to 76.90 to a dollar when RBI stepped in to support the rupee. Reliance Industries had started to announce its deals where global companies started investing in Jio Platform and Reliance Retail. From January-March 2020, FPI investment in the country (in respect of debt and equity) was a negative of $14.507 billion.

The lockdown announced on March 24 brought all economic activities in the country to a standstill. Migrant Labourers who did not have any work started returning to their home towns.

The RBI was already on a rate cutting spree as the GDP growth in the country had slowed to 4.7 per cent in December just before the pandemic. It increased the pace of cutting the rates in the last six months and brought Reverse Repo rates down to historic lows of 3.35 per cent in its meeting held in May 2020.

Stimulus packages

The rates were at their historic low, which attracted investments into the country. As the number of infections surged in April, May and June the Government released economic packages benefitting mainly farmers, the poor and MSMEs without actually retorting to deficit financing while most of the developed nations released huge economic packages to help their people and companies.

Thus a huge amount of liquidity was created by the central banks of these countries which started moving into the developing economies like India, China and Vietnam. This huge liquidity started a revival in the stock markets without the economy actually reviving and Nifty made a low of 7500 before it started to move higher and has recently touched a level of 13,000.

The RBI started buying the huge flows coming into the country due to the liquidity deluge and had bought $90 billion since March 31, 2020 to bring its reserves levels to $569 billion as on November 6, 2020. The inflows of foreign currencies were mainly due to FPI investment in equities (hot money), companies raising cheap money from outside the country (Trade Finance, FCNR Loans, ECBs), huge NRI inflows amounting to ₹35,000 crore in April-August 2020 (as people employed outside the country lost their jobs due to the pandemic and returned to India) and investment of $25 billion into Reliance Industries.

Since the debt market had peaked after the rate cuts , foreign investments in debt were meagre in fact negative since January 2020 at $14.160 billion. But the FPI investment in equities was $10.659 billion. FDI into the country increased by $35.71 billion during the April-August period which was 13 per cent higher than in the same period in the last year. The cheap valuations of companies during the Covid-19 period was also one of the main reasons for the increasing FDI into India.

Boosting reserves

All this combined brought huge dollar inflows into the country and the RBI has been buying these dollars to increase its reserves. But why has RBI been buying the dollars? Due to huge influx the Rupee started appreciating and reached a level of 72.80 while the pandemic took a toll on the country’s foreign trade volumes (particularly the exports). To ensure that we remain competitive the Centre and the RBI may have decided not to allow further the rupee appreciation and the central bank started absorbing the huge dollar inflows. The fall in imports particularly the petroleum products and gold also released the pressure on the Rupee as demand for these fell between March and July -2020.

The RBI in one of its policy had also announced that it would like to keep USD/INR lower to help overcome imported inflation but may be to help exporters (at the behest of the Centre) has abandoned that policy for the time being despite the inflation running 1.50 percentage points above the upper band of the comfort zone of 4-6 per cent.

The dividend angle

The RBI needs to give to the Centre a huge dividend and with the accumulated reserves needs higher USD/INR before March-2021 to pay the dividend. So a lower USD/INR is not in its interest and would for sure take the pair higher once the inflows ebb.

With the Centre giving a push to the ‘Make in India’ initiative and exports worth $500 billion yearly, it would like the exporters to be supported/incentivised. A depreciating currency never supports exports because in this globalised era the foreign importers also demand their pie and the extra cash flow due to the depreciation does not accrue to the exporters. But it does make the exports cheap and our products demand increases in the foreign country.

The oil factor

Oil is one of our chief imported commodity, the prices of which have been relatively stable and should not be our main concern in the next few months and the prices should range between $40-60 per barrel. With the government focus on ‘vocal for local’, imports should also come down. In fact they have been down in the current financial year till October 2020 by about 35 per cent while exports are down just 19 per cent. The current account and balance of payments should not be a matter of concern.

Though the RBI says that it only controls the volatility in the currency and not its direction it is a well known fact that USD/INR is a completely controlled currency and its value depends on the direction the RBI wants.

In view of the buying of dollars by the RBI, the dividend that they are required to pay and the Centre’s desire to help the exports and exporters, despite the Global Liquidity entering into the country in a big way, the RBI will keep absorbing the dollar influx and the day it finds that the liquidity has dried it will take the dollar higher to ensure its commitment of a higher dividend to the Centre particularly in this Covid-hit financial year.

So we may expect the rupee to touch between 75-76 levels in the last quarter of the current financial year. Also in December 2020 there can be outflows as the equity market is running at a high PE of 35 while its long-term average is 15-18.

FPIs may book profits and take some money back. The confirmations of the US presidency are in December/January and the process could be a difficult one given that Republicans are in majority in most of the states and this could cause tremendous volatility.

Most Asian currencies have appreciated in the last three months particularly CNH and KRW. Recently it was heard that central banks of these countries could be buying the dollar to protect excessive appreciation and their exports. Given the above circumstances the USD/INR pair could appreciate in the medium term.

The writer is Head of Treasury, Finrex Treasury Advisors

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