Even as the Reserve Bank of India (RBI) continues to claim it is not trying to defend any particular level of the rupee and only intervenes to manage volatility, the battle for 80 appears to be fully joined.
On the one side is the US Fed, finally fully awake, and focused on taming inflation by continuing to raise interest rates and holding them there for as long as necessary, even if it means pushing the economy into a recession. Chairman Jerome Powell’s Jackson Hole speech was about as clear as it could be. The only fallout so far has been from market analysts—the tremors haven’t really hit the real economy, and it will be interesting to see how Volcker-like Powell turns out to be as unemployment starts to climb noticeably. Of course, given the rude strength of the US economy, this may take a long time, which will make it easier for the Fed to stick to its guns. Credit also to president Joe Biden who, thus far at least, is not making any squawking sounds; rather, he is focused on his job by, for instance, pushing through the student loan forgiveness plan.
The moves have, of course, pushed the DXY to its highest level in over 20 years, which is increasing the pressure on all other currencies, including the rupee.
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On the other side is, curiously, the market itself, which appears to be positioning India in a stronger place after the Russian invasion. The much-discussed plan to bring Indian government bonds into global indices has come to life with JP Morgan’s announcement last week that the subject is under current discussion. With Russian bonds (which made up about 1% of global bond indices) removed as a result of the sanctions, many institutional investors are nervous about the lack of diversification in the indices, which has brought forward India’s opportunity even though we will not allow trading of our bonds off-shore. Most analyses suggest that this move could immediately bring $30-40 billion into our markets, and, even as the final button may take a few months to be pushed, investors are certain to climb into the market earlier. Already, local bond yields have started to dip.
Again, with China—particularly the real estate sector—continuing to show distress, and, importantly, the negative geopolitics highlighted by the Russian invasion and Chinese sabre-rattling in Taiwan, India’s place in the investment sun, discoloured as it remains as a result of our weak processes, will certainly get ever stronger.
And in the middle is RBI, our champion wrestler, obviously not focusing on the eight-zero number but pulling its huge weight in keeping the rupee just at or barely above that level. The reserves are down by $70 billion since the start of the year, $50 billion of which is the result of net spot dollar sales, but RBI appears unbowed. Certainly, at the last MPC meeting in early August, the Governor and the entire team appeared hardly bothered that the reserves were depleting so rapidly (or, for that matter, that the trade deficit had hit a record high). As the Governor said, you buy an umbrella to use when it rains.
The big question is how long it will continue to rain and how much worse it (dollar strength) can get. We note, first of all, that nothing goes on in one direction forever. Secondly, DXY has already retreated (marginally) from 108.90 once, although, to be sure, there is clear technical air above 109 all the way to 112 or so.
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However, it is possible that sooner rather than later, investors may realise that the Fed is serious about bringing inflation down, in which case, equities would continue to soften (but not collapse) and the dollar would stop its raging strength.
In the meantime, we can remain assured that RBI will remain fully engaged in the battle, and be willing to spend another $20 (or even 50) billion to protect the level that they are not specifically focused on.
Expect continued narrow but high volatility for the rupee—don’t take any fresh bets.
P.S. Another interesting thought from all this is that inflation in India appears to be—finally—at a level that is comparable (indeed, currently, lower than) with that in the US and other developed markets. Perhaps, global investors, who routinely expected a 4-5% decline in the rupee to account for inflation differentials will be thinking a different tune going forward.
The writer is CEO, Mecklai Financial
http://www.mecklai.com