Forget hiking rates, here’s how RBI has quietly tried to stem rupee slide

Publish Date: October 23, 2018

India’s Reserve Bank of India sprang a surprise on October 4 by refraining from hiking lending rates. Expectedly, the rupee weakened to an all-time low — it fell below Rs 74 against the US dollar — attracting criticism from several quarters.

But on closer scrutiny, it seems that the RBI has indeed taken steps to cushion the rupee in the past few months. It has been active in the currency spot, currency forward and futures market to ensure the rupee doesn’t weaken beyond control.

But before understanding the RBI’s handiwork, it is important to know why many economists were worried about the RBI’s inaction, its refusal to hike lending rates.

Less attractive debt market

Critics argued that the RBI’s paralysis would plunge the rupee to further lows.

Instead, they would have preferred the RBI to hike rates and keep the domestic debt market attractive for foreign investors.

They felt that keeping India’s debt market in good shape was especially crucial at this juncture because the US Federal Reserve had hiked their interest rates just a few days before.

It is important to note that foreign investors look at markets that would offer the highest rate of returns. So, in this case, since the RBI hadn’t increased its rates and the US Fed had, India’s debt market seemed less lucrative.

Now the question arises: what does this have to do with the rupee?

Strong capital flight

As mentioned earlier, since India’s debt market seemed less profitable when compared to other overseas markets, foreign investors started pulling out their money from India. They were now putting their money in markets that gave them higher or more quality rate of returns — for example, the US.

In fact, overseas investors pulled out Rs 12,167 crore in the first three weeks of October alone!

Therefore, draining out of such a huge amount of money from India resulted in a weaker currency.

That’s because foreign investors started selling the rupee to buy more US dollar assets. Since the demand for rupee fell, its value ebbed as well.

As a result of heavy capital outflow, the rupee plunged to an all-time low of 74.42 against the US dollar. In contrast, the rupee was at 63 at the turn of 2018.

RBI intervention

The Reserve Bank of India has kept a close eye on the rupee’s trajectory. It may not have hiked rates in October, but it has been actively selling US dollars in the spot, forward and even futures market.

Currency spot, forward market and futures market are three places where currencies are bought and sold.

Between April and August, the RBI sold roughly $40 billion from its reserves in the spot and forward markets. It also sold an additional $10 billion in the futures market as well.

In total, the central bank sold more than $50 billion in the currency markets to bring some stability to the rupee. By selling US dollars in the market, the RBI has succeeded in protecting the rupee from further slide by improving the currency’s demand in the foreign exchange market.

Gauging by the foreign exchange reserves, it seems that the central bank has been consistently tapping the spot and forwards market of late to halt the rupee slide.

To sum up, the RBI has been playing its part of insulating the rupee from excessive volatility. Although it adopted a wait-and-watch stance on lending rates, the central bank has remained fleet-footed in the currency markets to rein in the rupee.

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