Even as the Indian rupee has depreciated, to trade at an all-time low of 81.93 against the US dollar after the surge in the dollar index on Wednesday, State Bank of India (SBI) feels that the Reserve Bank of India (RBI) should allow the domestic currency to depreciate a bit further and find its natural balance.
In a report, Dr Soumya Kanti Ghosh, group chief economic adviser of SBI, says, "We believe a limited period of rupee depreciation might be a better way to wade through the current period of turbulence. It must be mentioned that even as the dollar index has surged by 17.1% since the Russia-Ukraine war broke out, the rupee has only depreciated by 7.8%, indicating the RBI has been leaning against the wind in terms of managing the currency and it may pay off now with a little bit of leaning with the wind, though only to an extent."
In recent times, selling by foreign investor class has accelerated with extreme uncertainty as investors shun asset classes en masse, preferring the relative security of cash. However, SBI says the Indian markets have performed much better.
"Specifically, the rupee has been holding remarkably well with RBI intervention supporting in the market. This is in sharp contrast to the 2013 taper tantrum crisis when the rupee was witness to significant volatility for a prolonged stretch of time," it says.
According to the report, the non-deliverable forward (NDF) for three-month tenure shows that three months forward rate for US dollar (USD) and Indian rupee (INR) pair is now over Rs82 per dollar. NDF is a short-term, cash-settled forwards contract that investors use to trade in currencies in an offshore market.
"Interestingly, the NDF market had factored a breach of Rs80 barriers from August. The implied yield on INR in the NDF is currently in the range of 4.25%. The yield is steadily rising from mid-August implying depreciation pressure on the rupee going forward," SBI points out.
Dr Ghosh also highlights the relentless pounding of global financial markets in recent weeks that has bought into sharp focus the dilemma that central banks are facing across economies in terms of stabilising the currency. "The bond rates against a rate cycle of US Federal Reserve (Fed) that now is likely to go beyond the earlier estimates."
"The rout in bonds markets globally has been exacerbated by the long road to contain runaway inflation, as central banks tighten the seatbelt to continue rate hikes spree, though Indian bond yields have been remarkably contained with even the latest state development loan (SDL) auctions of Rs27,000 crore going off smoothly," he says.
Investors are looking at elevated rates through 2023, dampening their appetite across asset classes, the SBI report says. "One of the possible reasons for the sharp increase in US bond yields that is having a material impact on emerging markets could be the sell-off in US securities by economies along with USD to protect domestic currencies."
SBI says, until now, countries are protecting their currencies with the depletion of forex (FX) reserves. FX reserves of China and Singapore declined by more than US$100bn (billion) in just six months. Even in the case of India, FX reserves has declined by US$86bn to US$546bn from their highs last year.
In the report, the group chief economic adviser of SBI also points out that there is no simple rule to augment capital flows by the RBI in the current scenario. "One possibility in the context of recent efforts by RBI to settle trade transactions in a non-dollar currency like Rouble is that if central banks come together and agree to peg the currency pair RUB/INR, making it agnostic to exchange fluctuation. In principle, exchange rate fluctuation has to be accounted for by the RBI to make the scheme successful."
According to Dr Ghosh, the fear of recession in India is unfounded. He says, "Amongst so many indicators, the performance of equity markets also substantiates this fact. While the foreign equity markets' year-to-date (YTD) decline in 2022 is in the range of 20%-30%, in the case of India, the decline is merely 3.5%. Not even Indian markets are the lowest loss generators; they are stable also. Hence, in 2022 so far, Indian equities have shown resilience relative to most of the advanced economies and peers from the emerging market economies (EME)."