MUMBAI: Just a few months ago, the Reserve Bank of India had to sell record amounts of dollars to prevent the collapse of the rupee as global investors fled the market because of a deteriorating economy and talk of the US Federal Reserve scaling back its stimulus programme, among other reasons.
But the central bank may soon start having to buy the US currency to prevent the rupee from strengthening to a point where it starts hurting the economy. It may also buy from currently copious inflows to create a foreign exchange reserve buffer that would be about 10% lower than what it was in 2008, when the global financial crisis broke out, sparking a market rout. Dollar purchases will also protect exports from getting hit by weakening emerging market currencies, including the Chinese yuan, said traders and economists.
The Indian rupee’s gain of nearly 4% since Raghuram Rajan took over as central bank governor in September may be a sign of approval for his policies.
But keeping exports healthy is critical as they have helped in lowering the current account deficit, which had widened to a record last year.
Worryingly, exports contracted in February after a seven-month expansion run, the government said on Tuesday. Meanwhile, expectations of a stable government after the upcoming elections have buoyedmarkets, which is adding to rupee gains as foreign investors have rushed in, driving stocks to successive records.
With global trade in flux and China possibly set to depreciate its currency to boost slumping exports as domestic growth slows, India’s central bank may have few options left.
“RBI should be buying dollars now,” said Ananth Narayan, managing director (global markets) at Standard Chartered Bank. “When the vulnerabilities are still there, it may be judicious for RBI to buy dollars.”
Some companies would prefer a stronger currency, especially those with overseas debt. It will also lower the cost of imports, which would be detrimental to domestic industry as has happened in the past.
The sharp fall in the currency last year helped revive exports and contain imports as they became expensive. Restrictions on gold imports also helped narrow the current account deficit, the difference between spending overseas and exports, to 1.9% of gross domestic product in the December quarter, from 6.5% a year earlier.
The rupee ended 0.2% lower on Tuesday, near a seven-month high of 60.75 to the dollar. It was the worst-performing major emerging market currency last year, when it fell to a low of 68.84 to the dollar on August 28.
Foreign portfolio investors have pumped nearly $6.5 billion into Indian debt and equity since January. Allowing this to continue boosting the currency without building up reserves may expose India to volatility when the tide turns, for instance if the electoral verdict is indecisive.