Can the rupee fall be controlled? Business Line 10th Sept 2018

Hedging oil contracts and addressing export finance hurdles will help. The RBI should articulate its view on the rupee

The fall of the rupee has been quite sudden in the last few months and honestly no one is sure how the currency will move in future. There have been some signs of weakening of fundamentals, though admittedly the external factors are dominant. A stronger rupee vis-à-vis the other currencies, especially the euro, has led to systematic depreciation of global currencies. Nations like the East Asian economies are buffered by being export oriented. What can India do to stem the rot?

The first thing that comes to mind is that the RBI can start supplying dollars in the market to cool down the exchange rate. Up to June, the RBI had sold around $14 billion. Further, there were forward contracts purchased for $10 billion. Forex reserves have declined by $23 billion since March-end and is at around $400 billion now.

Realistically speaking, selling dollars is not practical as this can assuage the market only for a few trading sessions after which other factors will continue to drive the rupee down. Therefore, this is a short-term solution.

The second measure which can be taken is to talk the market down.

In the current situation there is a tendency for importers to rush in to buy dollars and exporters to hold back remitting their earnings on the expectation that the rupee will depreciate further. This exacerbates the demand-supply matrix for foreign currency and drives down the rupee further.

RBI steps

The RBI can ensure that export earnings come back to the country on time while importers should be urged not to rush in to buy dollars in advance. Alternatively, asking the importers to hedge can be attempted though it cannot be made mandatory. Making such statements will help lower the speculative element which comes into the picture every time the rupee keeps falling.

Third, the government should focus on exports and to the extent possible, especially on the tax credit/refund part, clear the coast for exporters. SMEs (small and medium enterprises) which are dominant in the export market have had tax refund issues and this needs to be sorted out.

Also, export finance is another problem which has been bothering exporters and impediments on this front too need to be removed. But this will work only in the medium term and cannot deliver result immediately because export markets tend to be relatively inelastic and are driven by demand factors.

Fourth, as oil is the major import component, and whose prices are rising, a separate window needs to be opened for selling dollars. Also, hedging processes must be put in place to ensure that the purchases are in order. OMCs (oil marketing companies) do take forward contracts to buffer against price changes, but to the extent there are open positions hedging should be made mandatory.

Fifth, the RBI would have to monitor the other components of demand for dollars — like it did previously, which was five years back — to ensure that there are limits to the drawal of dollars for other purposes such as travel, investment, and education. This could become a pain point where corporates may be taking dollars out for investment overseas, as opportunities within the country are limited.

Sixth, the channels for external commercial borrowing should be looked at judiciously. While urging companies to explore the market makes sense, it should be noted that un-hedged positions can put on pressure on debt servicing. Nevertheless, in these conditions, such borrowings would be helpful.

Seventh, the channel for considering a sovereign bond or any such scheme for getting expatriates to invest in such bonds should be planned in advance — which may not be required if conditions stabilise. We need to look at our forex reserves and import-cover position and have thresholds below which such bonds or NRI deposits schemes may have to be explored.

Such a policy would be worth having internally as there should be triggers that are known that would lead to such possibilities being looked at.

Capital flows

Eight, the capital flows need to be monitored proactively and this is where FPIs (foreign portfolio investments) matter. The strong inflow of FPIs has the power to rein in the rupee.

The recent issues regarding KYC norms can hold back such flows and regulators should look at minimising hurdles given the pivotal role played by this constituent. Further, while the RBI’s monetary policy target is primarily inflation control, the currency is also a secondary variable that is tracked and increasing interest rates could help in drawing in FPI flows to the debt segment.

While these options need to be a part of the list that the central bank and the government need to keep on the radar, the causes for depreciation are important. When fundamentals drive the rupee down — and here oil imports are relevant — the authorities can work on improving them by addressing various components on the capital and capital accounts.

However, when the prime driving force happens to be external factors like US’ trade war with China and Turkey , which results in the dollar strengthening, there is little that can be done to hold back the rupee.

Making affirmative statements will help to steady the rupee so that the speculative element lays low. In the market there is always a view that the country is better off with a weaker rupee as it helps to increase exports. Whether or not this premise is right, the market looks to the RBI on its view on the rupee.

While the RBI maintains that it has no view on the rupee value but is interested only in its orderly play, it is interpreted as the central bank being satisfied with the depreciation. This is a good reason to trigger further depreciation. By expressing a view, the RBI can send signals to the market, which will work better than direct intervention as the ‘sentiment’ factor is addressed. While ₹69.5-70 to a dollar looks to be fair in normal conditions, the length of the volatile phase can pull the rupee down substantially until equilibrium sets in. In the very near term though, ₹72-73/$ cannot be ruled out.