The weakness in the dollar following the large stimulus rolled out by the US has resulted in currencies of most emerging economies strengthening sharply from April this year. Yet, the rupee has been the worst performer among Asian currencies in 2020, losing 3.59 per cent against the greenback.

This is despite strong tailwinds in the form of foreign portfolio flows and shrinking trade balance. The RBI’s intervention in the currency market appears to be largely responsible for the rupee’s weakness.

China’s Renminbi, the Philippines’ Peso, Taiwan’s dollar and Korea’s won were some of the Asian currencies that appreciated over 4 per cent against the dollar this year as the greenback index slid more than 10 per cent from its March peak due to the monetary easing by the US Federal Reserve.

The rupee, too, appreciated almost 4.7 per cent between March and October, from 76.3 to 72.7. But the Indian currency has been depreciating, over the last two months.


Copious FPI inflows

The weakness in the rupee is surprising given that there have been copious inflows from foreign portfolio investors over the last two months. India and China have been the only Asian countries where FPIs have invested heavily in 2020.

Foreign direct investments in the April-September period have also been robust, 23 per cent higher over the previous period. Monthly merchandise trade deficit averaged $3.9 billion in April-September compared to the average monthly deficit of $12.9 billion in 2019, as the pandemic affected global trade.

The current account balance, therefore, moved in to the positive territory in the June 2020 quarter, after 16 years.

But despite these positive, the rupee has been weakening, largely due to the RBI’s interventions. While the central bank sold dollars to support the rupee in March and April, it has been a net buyer of dollars since then. The RBI’s net purchases hit a high of $15.9 billion in July, when the rupee was trading around 75 against the greenback.

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While data on RBI purchase and sale of dollar are not available beyond September, the increase in forex reserves from around $540 billion to $575 billion since October indicates the central bank has once again been mopping up dollars over the last two months.

The RBI’s intervention seem aimed at helping exporters, who benefit from a weaker rupee, but experts question the need for continuing this policy in the current circumstances.

“In the current fiscal, the RBI has already accumulated $93 billion in forex reserves… In the current environment of liquidity surplus should the RBI continue its intervention in the market and prevent rupee’s appreciation or should it allow the rupee to appreciate?” questioned Soumya Kanti Ghosh in SBI Ecowrap.

He pointed to two problems of continued intervention. One, bank loan rates are lower than equivalent rated bonds due to surplus liquidity created by the RBI’s dollar purchases. This can impact banking sector profits and set off asset-liability mismatch, if the spread is more prevalent for lower rated borrowers. Two, Ghosh thinks given the higher domestic inflation, it would do no harm for the RBI to lean with the wind and let the rupee appreciate, which would reduce imported inflation when metal prices are rising.

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