How much more FX will RBI buy?

November 25, 2020 7:00 AM

This is the first time that RBI is entering a possible Democratic administration with adequate FX reserves. We now expect RBI to buy $77billion ($66.3 billion FYTD) in FY21 at an expected current account surplus of 1% of GDP

RBIThe RBI had to mount two bank rescues in 2020 -- Yes Bank and Lakshmi Vilas Bank -- using disparate means in each instance to reach the same end of a fast and successful resolution.

By Aastha Gudwani & Indranil Sen Gupta

We have raised our FY21 RBI FX intervention forecast by $6 bn to $77 bn (see graphic). This follows an upward revision of our current account surplus forecast by 20 bps to 1% of GDP. The trade deficit worsened to $8.7 bn in October from $2.7 bn in September as exports fell again, led by oil. Imports, however, continued to decline, but at a slower pace, as both gold and non-oil, non-gold imports performed relatively better. We project the current account surplus at $13 bn in the September quarter, down from June’s $19.8 bn. Our BoP estimates place FY22 RBI FX intervention at $45 bn at a current account deficit of 0.5% of GDP at our oil strategists’ $50/bbl Dated Brent forecast.

We continue to expect RBI to follow an asymmetric policy of buying FX when the USD weakens and allowing INR to depreciate when it strengthens. After all, high FX reserves are India’s only buffer against potential contagion in an uncertain world. We, thus, do not expect RBI to let its guard down easily. A policy of trying to allow appreciation of the INR at the cost of FX reserves in 2009-11 finally led to massive depreciation in 2011, 2013 and 2018. It has only been in the last ten years that Governor Das has been able to rebuild adequate FX reserves.

We continue to expect RBI to follow its asymmetric policy of buying FX when the USD weakens and letting INR drift towards Rs 75/USD if it strengthens under the Biden-Harris administration. Our US economists now expect a fiscal stimulus of $500 bn-$1 tn in February in their base case. In case of a greater-than-expected stimulus, RBI will likely buy up risk-on foreign portfolio investment (FPI) flows to add to FX reserves. In case of a disappointment leading to a risk-off in markets, we see RBI letting the INR weaken to Rs 75-76/USD.

We prefer to see economic/market movements as products of global cycles rather than a country’s political leaders. Still, experience tells us that a stronger USD led to a weaker INR under Democratic presidents Clinton and Obama. However, this is the first time that RBI is entering a possible Democratic administration with adequate FX reserves.
Note that the US has seen relatively higher growth (2.7%) under Democrats than Republican (2.3%) presidents. This has led to relatively higher Indian growth under Democrats (6.5%) than Republicans (6%) (see graphic). We expect India’s gross value added (GVA) contraction to moderate to 7.8% (from -11% earlier) in the September quarter from June quarter’s 22.8% (see graphic). Public expenditure remains a swing factor; we expect it to turn flat in Q3-20.

Our BofA India Activity Indicator fell 2% in September atop the 5.3% decline seen in August (adjusted for Covid-19 monthly data issues). The September quarter contraction eased to -5.1%, from June’s -20.3%. We also retain our 7.5% FY21 GVA contraction projection with Covid-19 cases persisting at 40,000+ levels, pushing out restrictions further. This reinforces our view that the situation remains grim, although we think the worst is over.

Bank credit offtake remained weak, despite falling real lending rates. While nominal marginal cost of funds based lending rate (MCLR) has come off by 140 bps, since March 2019, on RBI easing, real MCLR is down 75 bps, with core WPI inflation dropping to 1.6% in October from 2.3% in March 2019, on falling demand. We expect a further 15 bps MCLR cut by March.

Although loan growth jumped to 5.7% on 6 Nov from 5.1% on 23 Oct, it was largely driven by Diwali base effects. (Diwali was celebrated on November 14 this year, much later than October 27 last year). Credit flows between mid-November and mid-March (i.e., covering the lockdown) are still down 16.3% vs 2019.

Edited excerpts from BofA Securities Emerging Insight report
(dated November 23, 2020)

(Authors are India economists, BofA Securities. Views are personal)

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