In the week ended October 12, the reserves fell by $5.14 bn; however, over the week the dollar weakened globally (by 0.8%), which increased the dollar value of the non-USD reserves. This means that the actual dollar selling by RBI was higher than the reported number; one estimate suggests total dollar sales were about $6.1 bn, which would make it the largest weekly intervention since the worst of the 2008 crisis.
In the event, the effort was successful in preventing the rupee from falling below 75 to the dollar. Of course, the drama made global investors, already stressed by the IL&FS default, even more nervous, with outflows increasing daily. Interestingly, the total outflows (from both equity and debt markets) so far this year are just 40% of the money that came in during 2017. This means that investors are not totally spooked yet.
The good news is that the rupee appears to have steadied—it is 2% higher than its recent lows. This is probably as a result of both oil prices coming off the burn and banks unwinding long dollar positions to address the rupee liquidity squeeze. The danger, however, is that any further drama could see more outflows, leading to renewed—and, perhaps, increased—pressure on the rupee.
Globally, markets are in a funk—the Dow has fallen by more than 8% since the start of October, China has delivered its lowest growth in years and gold bugs are creeping out of the woodwork. A very astute analyst I rang said he felt November 6 is D-day—if Trump pulls a rabbit out of the US House of Representatives (and assuming he keeps his sheep in line in the Senate), US markets could really tank with a terrified OHHHHHSHHIT!
How this affects EMEs is an open question. If markets see this as “more of Trump” meaning more trade madness meaning higher inflation, the impact on emerging markets could actually be positive, since money may flow out of the US as the dollar declines. Unfortunately, India is hardly as prime a beneficiary as it was till, say, last year. In addition to the NBFC problems, the political season is starting in earnest, and the state elections over the next few months will keep things uncertain.
In any event, the direction of the dollar is hardly certain—the DXY has recently crossed an 18-month high and is not far from a long term resistance, which, if breached, could open up some real blue sky for the dollar. Europe is wobbling—Brexit, Italy, etc—and a Euro and/or sterling dump would not really surprise anyone.
The poor rupee, of course, is left to its own devices, with RBI—“we’re only monitoring volatility”—the only support. With a strong possibility that volatility will rise sharply again, the rupee could once again go into another tailspin, and with RBI torn between preventing more rupee terror and ensuring less liquidity terror in the debt market, things could get really bleak. While India Inc. appears to still be breathing after the last hit, another sharp decline in the rupee from this level may be lethal.
Prevention is always much better than cure, and so, this is probably an excellent time for the government and RBI to trigger a plan to bring in dollar capital. Getting PSU NBFCs’ to draw down undrawn FX facilities may not work since, in many cases, these liabilities have to be tied to an asset. An NRI bond seems to be just the ticket; the good news is that there is increasingly loud talk of a $30-bn NRI bond, which could be quickly brought to market. Interestingly, the one month NDF arbitrage has all but disappeared, suggesting that market is expecting some kind of action soon.
While an NRI bond would doubtless have all the problems associated with the last one—primarily giving banks and NRIs a free ride—it would instantly address both liquidity and rupee support issues. The rupee would certainly strengthen, possibly towards, or even above 70. So, when (if?) the next market tsunami hits, the rupee’s decline will simply bring it back to the last low of around 75, which RBI may be able to cap with intervention and, if necessary, an interest rate hike.
Brace for continued volatility. Exporters should reduce their tenor of risk identification and, correspondingly, imports should extend theirs where possible.