Perhaps, it makes sense for RBI to save its powder to intervene after the rupee’s next step down
Some time ago, I saw a set of forecasts for USD-INR—the range for October-end was 73.50-75.50; for December-end, it was 73.50-76.00. My first thought was that since so many forecasters had largely the same view, there could be a very big move if the views turned out wrong.
And sure enough, threatening that, the rupee hit a low of 75.67 on October 12; but, with RBI out all guns blazing, it recovered a bit of air. And, given RBI’s gigantic war chest—over $575 billion of foreign currency assets, plus a further $50 billion or so of forward purchases—it should be well positioned to hold off any attack. But the question is whether it should fight at this point or wait for a better time.
Oil prices have already crossed $85 a barrel and talk of $100+ is more than just the talk it usually is. In addition to OPEC staying pat, the bigger—and possibly more sustainable—issue is the price of natural gas that is used for home heating in several countries in Europe. Gas is already more than five times more expensive than it was last year, and with shipping tankers in short supply, imports will be harder to come by. Obviously, given the balance between oil and gas BTUs, as long as gas supplies remain tight, oil will stay high.
There is another reason to believe this problem may persist. The shift towards greener fuels, particularly in Europe, has structurally increased the demand for gas as a half-way house between oil/coal and solar/wind. Again, for the same reason, there has been a lack of enthusiasm for investment in non-renewable energy since it is clear that these investments will be obsolete in 25-30 years.
Now, oil prices are well known to be a critical determinant of the value of the rupee; so, if oil prices are likely to climb another 20-25% and, more frighteningly, stay there for a while, it may not make sense for RBI to burn its reserves at this level. Technically, there appears to be an open abyss below 76, and it has been over a year and a half since the rupee has set a new low—the last one was 76.78 in April 2020. Of course, a weaker rupee and higher oil prices would create even greater difficulties for the people, which could translate to a major issue for the government with state elections coming up soon. Perhaps, the apparently reasonably strong deficit position will enable the government to cut levies on petroleum products to ease the burden on the poor.
But, even if the government is able—willing—to do this, there is no hiding from inflation. Most analysts who spent the past year or so insisting that the rise in prices was transitory and would ease as supply constraints did, are acknowledging that several price rises are likely to be more permanent. For instance, I was shocked to discover that the dramatic shortage of truck-drivers in the UK (and the EU) was because truck-drivers’ salaries had not risen in 25 years. As a result, most truck drivers shifted careers a long time ago; the pressure did not come to bear since there were always people from the poorer parts of Europe—Romania, Albania—who were happy to work at whatever wages they could get. Clearly, this cost increase will be permanent and will feed into the cost of a wide array of goods.
Then, there is China. And while there is no doubt that China, under its governments’ dispensation, is slowing down, which will broadly reduce demand for a wide swathe of industrial materials, the reality is that there are also huge supply constraints in most of these, because of both under-investment and supply chain tightness. Thus, it is unlikely that there will a significant mitigating impact of China’s slowdown on global prices, whether for energy or other raw materials. The Fed and its sisters have, apparently, woken up to this and we will certainly see interest rates rising sooner than anticipated; what is not yet foreseen is how much they will rise. RBI will ultimately have to respond to rising global rates, but it is likely that it will be reactive, particularly with the government’s disinvestment program just beginning to bear fruit.
Thus, the stage is multiply set for a weaker rupee and, perhaps, it makes sense for RBI to save its powder to intervene after the rupee’s next step down.
CEO, Mecklai Financial