RBI INTERVENTION

Subject: Economics

Context: The weakness in the dollar following the large stimulus rolled out by the US has resulted in currencies of most emerging economies strengthening sharply from April this year. Yet, the rupee has been the worst performer among Asian currencies in 2020, losing 3.59 per cent against the greenback.

Concept:

• This is despite strong tailwinds in the form of foreign portfolio flows and shrinking trade balance. The RBI’s intervention in the currency market appears to be largely responsible for the rupee’s weakness.

Despite FPI/FDI Inflows:

• The weakness in the rupee is surprising given that there have been copious inflows from foreign portfolio investors over the last two months. India and China have been the only Asian countries where FPIs have invested heavily in 2020.
• The current account balance, therefore, moved in to the positive territory in the June 2020 quarter, after 16 years.
• But despite these positive, the rupee has been weakening, largely due to the RBI’s interventions. While the central bank sold dollars to support the rupee in March and April, it has been a net buyer of dollars since then. The RBI’s net purchases hit a high of $15.9 billion in July, when the rupee was trading around 75 against the greenback.
• While data on RBI purchase and sale of dollar are not available beyond September, the increase in forex reserves from around $540 billion to $575 billion since October indicates the central bank has once again been mopping up dollars over the last two months.
• The RBI’s intervention seem aimed at helping exporters, who benefit from a weaker rupee, but experts question the need for continuing this policy .

Problems :

• Bank loan rates are lower than equivalent rated bonds due to surplus liquidity created by the RBI’s dollar purchases. This can impact banking sector profits and set off asset-liability mismatch, if the spread is more prevalent for lower rated borrowers.
• Given the higher domestic inflation, it would do no harm for the RBI to lean with the wind and let the rupee appreciate, which would reduce imported inflation when metal prices are rising.