The Reserve Bank of India continues to shake things up in the FX world with unscheduled meetings with monetary policy announcements in order to boost the Rupee. The RBI is facing a common dilemma. India has a current account deficit that alongside a weak currency will lead to slower growth as imports grow more expensive. The central bank is trying to keep the currency low by discouraging speculation by contacting large currency trading desks and suggesting they only trade non-speculative INR positions. Oil refiners have also been directed to get their USD from a single source bank to avoid multiple bids fuelling speculation. The latest move by the RBI was to increase the borrowing rate.
Daily Rupee – US Dollar Chart
The official statement on the RBI website highlights:
The market perception of likely tapering of US Quantitative Easing has triggered outflows of portfolio investment, particularly from the debt segment. Consequently, the Rupee has depreciated markedly in the last six weeks. Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals. The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in part because of the improving domestic liquidity situation.
OANDA MarketPulse Analyst Mingze Wu wrote earlier about the impact of the RBI rate hike:
The Reserve Bank of India tried to support the beleaguered Rupee by raising the Marginal Standing Facility by 2 full percentage point, pushing up the cost of funding from 8.25% to 10.25%. This is in response to the failure of RBI to strengthen Rupee via purchasing of Rupee via the secondary markets
With this rate hike, and the narrowing of borrowing allowance for banks to just 1% of deposits, is expected to drain liquidity of Rupee and hence prop INR higher. The Central Bank also hope that these measures will compel banks to seek other means of funding – e.g. from depositors which would mean higher rates for short-term borrowings, commercial papers and deposit rates, which will drain liquidity even further. However, this would also mean that mortgages and other commercial loans will be more expensive, discouraging consumer spending and commercial spending during a time when India is fighting the slowdown in growth rates.
Monthly Rupee – US Dollar Chart
The decision by the central bank paid off in the New York trading session. Although it might be argued the INR would have been boosted by USD weakness after a lower than expected retail sales and the speculation surrounding tomorrow’s address to the US congress by Fed Chairman Ben Bernanke. Weaker growth has hurt the Indian currency in the past quarter and when Fed tapering fears exploded it had nowhere to go but down versus the USD.
Central bank actions will be one of the topics of discussion as the G20 meet in Russia this week. The IMF has outlined the top three risks to global growth to be 1. China, 2. Abenomics and 3. Fed Tapering. For India’s currency the third risk has proven to be the most difficult to deal with. Even with all the current measures being implemented it is hard to imagine the RBI could stem the outflow of capital that is weakening the currency. Investors have not been impressed with lack of structural reform that can guarantee a solid return. Inflation continues to climb and reduces the attractiveness of higher yield in the emerging market.
Fed Chairman Ben Bernanke will be discussing the US Economy in front of Congress on Wednesday and later on Thursday he will face the Senate. The biggest question mark for the market is how will he address the tapering of the US bond-buying program. Some clarity before the next FOMC meeting at the end of July would be welcomed. A quick Fed QE timeline would be as follows:
- First Bernanke hinted at the end of QE during the June 19th FOMC statement.
- The following week Fed members contradicted, or as they called it clarified the Bernanke statement.
- Employment is front and center in the QE exit strategy, so when NFP came in higher than expected on July 5th the markets sold the EUR.
- On July 10th the Fed’s FOMC minutes came out and showed there was an internal division within the members.
The dates have a heavy correlation with the INR touching all time lows as funds have left India in anticipation of reduced carry opportunities. It remains to be seen if the RBI will be able to contain the outflow with a combination of soft and hard policy measures.