Will Rbi need to raise rates to shore up the rupee?


The title question has repeatedly been answered by successive Reserve Bank of India (RBI) governors, including Shaktikanta Das, with a resounding “no”. As an inflation-targeting central bank, governors and deputy governors have repeatedly asserted that interest rates will only serve to target inflation. Yet dealers today wonder if the rupee will become a reason for RBI to accelerate rate hikes, given the Indian unit’s steady fall to new all-time lows virtually daily since mid- June.

Evidence of this sentiment is the movement in the ten-year government bond yield this week. That yield fell from 7.39% at the close on Tuesday to a low of 7.33% on Wednesday, reacting to the weaker-than-expected consumer price index (CPI) of 7.01% in June, which is Tuesday after market hours. But from those lows, the yield climbed to a high of 7.4% on Thursday and then 7.44% on Friday in reaction to the scorching US CPI of 9.1% that came in late Wednesday.

The rise in yields was explained by dealers as a reaction to federal funds futures which began pricing in a higher probability of a 100 basis point hike by the US Fed at the next Federal meeting. Open Market Committee (FOMC) on July 26 and 27.

Explaining market fears, B Prasanna, head of treasury at ICICI Bank, pointed out that after the August 4 meeting of the Monetary Policy Committee (MPC) and when they meet again in October “the Fed probably would have gone up 150bp either in two 75bp tranches or 100 and 50. And so even if the RBI goes up 50bp (in August) you are still behind the Fed Interest rate differentials will come down and if they come And if the term premiums go down, it actually discourages exporters from selling (dollars) which doesn’t create enough demand for INR” Prasanna said, however, he cautioned that he does not expect a higher terminal repo rate because of the rupiah, he only expects the RBI to levy the rates.

Another broker pointed out that by allowing a hike in the offered rates on non-resident (bank) foreign currency deposits (FCNR(B)), the RBI was already rolling out the interest rate tool using the rupee. Others pointed to the chorus of rate hikes around the world, including in emerging Asian markets. Over the past week, the central banks of Korea, New Zealand, Canada, the Philippines and the Monetary Authority of Singapore have raised rates – in several cases unexpectedly and in most cases more provided that. Rate hikes were between 50 and 100 basis points. A veteran treasury chief at a major foreign bank pointed out that in this chorus, a 25 basis point hike would make the RBI sound like a dovish outlier and could invite speculative shorting of the rupee by foreign funds.

An equal number of respected experts reject this argument. Neeraj Gambhir of Axis Bank pointed out that inflation in India is lower than in the United States; moreover, India’s June inflation at 7.01% is much less above the RBI’s 2-6% target than the US CPI, which at 9.1% is 700 basis points higher. based on the Fed’s 2% target. India has no need to emulate the Fed in any way, he argued.

Anant Narayan, professor of finance at the SP Jain Institute of Management and Research (SPJIMR), echoed this point. “I think we are a long way from a situation like that. On the one hand, the rupee continues to be overvalued by almost every metric you look at. So if anything, you should allow the rupee to depreciate a little” and use the abundant reserves to control the pace of depreciation, he said. “The only case where you would consider a monetary aspect of currency defense would be at the extreme where the rupiah has completely swung the other way and you are running out of reserves,” he added. “It’s not in our MPC mandate, and it shouldn’t even be considered right now.”

Anant brings up a crucial point. The MPC is the rate setting body, not the RBI. And the MPC has no jurisdiction or responsibility over the rupee. He must provide a CPI of less than six percent and he can only use the repo rate for that purpose. Right now, the RBI may not have a problem raising rates as they need to bring inflation down to 4%. A theoretical dilemma only emerges when inflation is well under control but a rate hike is justified to arrest the rupee’s fall.

The markets are not currently worried about this theoretical subtlety. Their fear relates to the imminent tightening of rates between India and the United States. Kaushik Das, an economist at Deutsche India, pointed out that the difference between India’s repo rate and the Fed rate is already small. If the Fed opts for a 150 basis point hike over the next two months and the RBI is only up 25 basis points in August, the difference between Indian and Fed rates will narrow to less than 200 basis points. base, which would be the lowest in history. “You have to keep this in mind that you can’t ignore the interest rate differential,” he said.

The interest rate differential argument is weak, said another central banker. “What differential of interests”, he asked. “Between the dollar and the rupee? Between yen and rupee? Pound and rupee? His argument was that the real differential doesn’t impact flows, but market sentiment does. So RBI will have to play it by ear. If the currency markets are in turmoil and there is irrational fear, the RBI may have to use whatever it takes, including the interest rate tool, if the cost of not doing so is high.

Currently, RBI is managing the Rupee drop well with a mix of selling from its reserves and intervening in the futures market. But the world waters are treacherous and the sentiment can change in no time.

In early August, when the MPC meets, Fed May just made its first 100 basis point hike. Many economists are already expecting a 50 basis point rise in the RBI on August 4, and the market chorus may intensify as the time approaches. If so, RBI may have to respond with a 50-60 basis point hike, bringing the repo to around 5.5%.

First post: STI


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