Forex reserves will cushion currency dive, say experts
The Turkish lira’s collapse starting Friday — the result of a US-Turkey trade spat — rippled across emerging markets, impacting India on Monday. A further knock on the rupee could spell economic troubles, economists said.Updated: Aug 14, 2018 23:31 IST
The rupee on Tuesday fell to 70.09 to the dollar for the first time, a psychological mark, but bankers and economists said India had the means — mainly sufficient foreign exchange reserves — to ward off extreme volatility or a currency free fall.
The Turkish lira’s collapse starting Friday — the result of a US-Turkey trade spat — rippled across emerging markets, impacting India on Monday. A further knock on the rupee could spell economic troubles, economists said.
“Given the kind of exchange rate depreciation, it will have a dampening impact on the current account deficit (CAD), on imports and could lead to more borrowing. It’s alarming,” said NR Bhanumurthy, economist at state-run National Institute of Public Finance and Policy. “There is no option but to increase the interest rate so that rupee becomes more attractive.”
A weak rupee toughens the RBI’s job of controlling inflation because it makes imports costlier. The RBI has already hiked rates twice in June. A depreciating rupee will worsen CAD, which results from the economy spending more foreign exchange abroad — mainly to buy imports — than it earns. India’s biggest import, in terms of value, is oil. This deficit is mainly financed by foreign exchange reserves. India current account deficit has widened from 0.1% in the beginning of fiscal 2017 to 1.9% in 2018.
Analysts said the RBI was in a position to thwart any rupee volatility given the country’s adequate foreign exchange reserves of slightly over $400 billion. Just like any other commodity, a currency strengthens, or becomes expensive, when there is more demand for it by investors. It weakens, or loses value against the dollar, when its demand falls, especially when investors sell off assets held in that currency.
India needn’t panic, said Gurbachan Singh, an independent economist and adjunct faculty at Indian Statistical Institute, Delhi Centre. “The effect on rupee is more through sentiment, than through fundamentals,” Singh said, adding India’s market linkages with Turkey were negligible.
Typically, India’s central bank uses a “managed float” policy — allowing the rupee’s exchange rate to move up or down according to supply-demand conditions in the foreign exchange market. Yet, the RBI will intervene when needed — mainly by selling dollar from its reserves — to ensure the rupee does not stray too far.
“I’d say just allow (the rupee) to float in a managed way and let it depreciate up to a realistic point, which RBI has to work out,” said economist M Govinda Rao. DK Joshi, chief economist CRISIL Ltd, said policymakers at this stage can do little other than control the volatility.