The Indian rupee has made a smart comeback in the past two weeks, gaining more than 1.5 percent against the dollar. While the recovery has been attributed to the cooling of oil prices, much of the credit actually goes to the Reserve Bank of India.
The RBI had scheduled a two-year sell-buy swap with banks worth $5 billion with the aim of elongating its forward dollar/rupee contracts that mature in the coming months. In such a swap, the central bank sells dollars immediately in the market with a promise to buy them back two years later. The positive outcome of this sell-buy swap was the supply of $5 billion to the market immediately, which supported the rupee.
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However, that does not entirely explain the $11.1 billion drop in the country’s foreign exchange reserves in the week ended March 11. The central bank’s data showed that this was the biggest drop in two years. Market participants say the central bank has stepped up its market intervention in addition to the scheduled dollar sales through the swap arrangement.
Sentinel at the gate
In the past, the RBI has resorted to deeper interventions during the rupee’s rough periods. The central bank has expanded its intervention tools ever since the taper tantrum of 2013. Besides the normal intervention in the spot forex market through designated banks, the RBI increased its presence in the forward market. It even entered into special swap deals with banks, similar to the one this year.
In September 2013, the RBI introduced a special concessional swap involving foreign currency non-resident deposits of banks. Through the FCNR swap, the central bank enthused banks to raise dollars and swap them at a concessional rate with the RBI. This swap resulted in $34 billion flowing into the domestic market. The arrangement helped shore up the country’s forex reserves.
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However, such an arrangement is unnecessary in the current context. Unlike in 2013, India’s external position is robust and the RBI has a record pile of forex reserves.
Going to the basics
The RBI’s market interventions have intensified over the past decade. Between FY04 and FY13, the RBI bought an average of $3 billion every month from the market. It sold $2.5 billion every month, an analysis of data from the central bank shows. This has almost doubled to average monthly purchases of $7 billion from FY14 to now.
It should not be surprising then that the RBI has come under the glare of the US Department of the Treasury. The US termed India a currency manipulator since the RBI’s interventions were close to 5 percent of the country’s gross domestic product (GDP).
Despite being on the list of manipulators for more than two years now, the central bank’s interventions haven’t slowed. The RBI has termed its interventions necessary in the wake of global volatility. In January last year, Governor Shaktikanta Das had pointed out that emerging market economies have no recourse to market intervention if they had to safeguard their economy from global uncertainties. The current heightened geopolitical uncertainties only give more reason for the RBI to remain a big participant in the market.
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Foreign portfolio outflows
There are, of course, pitfalls of too much intervention. Incessant dollar purchases tend to give foreign investors a lucrative exit from the domestic market. This could exacerbate outflows. Foreign portfolio outflows have risen to $6.3 billion so far in March from $5 billion in February and $2.8 billion in January.
Moreover, meddling in the forward market renders contracts is expensive for importers and exporters, depending on which side the central bank is on. Most of all, the cost of intervention is a setback to an otherwise straight path to a liberalised external sector that attracts foreign capital without any hang-ups.
That said, in the absence of a deep and developed domestic market, emerging economies such as India have no choice but to keep interventions sizeable.
For the rupee, this gives considerable protection against future volatility. At the tactical level, the central bank may ease its hold on the market during brief periods. A more decisive shift towards a freer market would, perhaps, have to wait longer in the wake of the current uncertainties.
