China’s move to devalue currency could act as a stiff barrier for the Reserve Bank of India’s plan of gradually increasing debt investment limits for foreign portfolio investors (FPI) as the central bank could otherwise struggle to prevent the erosion of export competitiveness amid an overvalued rupee. This could also potentially make RBI more aggressive in its dollar purchases from the forex market.
The rupee fell to 64.20/$ on Tuesday after the People’s Bank of China set the midpoint for the yuan 1.9% lower and said the closing of the yuan will determine the next trading session’s midpoint. The yuan is allowed to trade within a 2% band around the preset midpoint. Analysts feel this could potentially depreciate the yuan by as much as 10% in the coming days. In contrast, the rupee is overvalued 12% in real effective exchange-rate terms based on a 36-currency basket tracked by the RBI. Another gauge of competitiveness by the Bank for the International Settlement shows the rupee is overvalued by around 8%.
“There would be an increased volatility across the board. RBI would need to be more aggressive and maybe they would use this as an excuse to let the rupee go,” said Jamal Mecklai, forex market expert and chief executive officer of Mecklai Financial Services.
The rupee has been the most resilient currency in the wake of external shocks, such as Greece’s debt problems, the emerging views on the US Federal Reserve’s timing of rate hikes and even the rout in global bond markets. In fact, the 1.8% depreciation of the rupee in 2015 has been largely due to RBI’s dollar purchases in the spot market totalling $36.25 billion in the first six months. In such times, when the interest in the Indian market owing to the returns and an improving economic data could attract dollars in droves, the central bank will have to go slow on throwing open more of the debt market.
“More than the Fed, China’s devaluation is a far bigger deal now,” said Abheek Barua, chief economist at HDFC Bank. “The RBI will also have to intervene more in the market and use tools such as MSS to mop up liquidity,” he added. Ananth Narayan, regional head of financial markets for South Asia at Standard Chartered Bank believes the central bank may limit its interventions when the rupee depreciates. “The RBI should not be unhappy if the rupee goes to 65/$,” he said.