RBI governor hints at anchoring rupee expectations

In last few months, RBI and the MPC have been largely obsessed with managing inflation expectations. Now, the RBI has a new problem  on hand. The rupee is close to 80/$ and the dollar index is at a 20-year high. This makes the rupee vulnerable to spikes in volatility. RBI interventions have a limitation in that it depletes forex reserves and that is already evident. However, as the RBI governor has pointed out, RBI intervention has a bigger purpose. That pertains to anchoring expectations around the depreciation of the Indian rupee versus USD.

This is a new perspective to the RBI intervention altogether. Till now, the RBI has held the stance that its interventions in the foreign exchange market are intended to prevent excess volatility in exchange rates. Now the RBI has added a second principle or intent to its forex market interventions. While preventing excess volatility is still the basic intent, the other intent of the RBI is to anchor expectations around the depreciation of the rupee. Like the equity markets, currencies also have a psychological side to it and it needs to be managed.

The timing of the announcement by the RBI governor was also quite apt. It comes close on the heels of the rupee marking a fresh intraday low of Rs80.13/$ towards the end of last month. It was only the heavy market interventions in the form of dollar sales by RBI which helped the rupee to recover and close better than 80/$. Till date, the INR has already breached the 80/$ mark thrice and RBI interventions have played a key role. RBI is normally cautious around psychological levels as most stop losses tend to get hit beyond this point.

Till date, in the year 2022, the Indian rupee has depreciated 6.9%, which is not too bad considering that in the same period, the Dollar Index (DXY) has appreciated by 11%. However, this has been an outcome of the RBI heavily intervening in the foreign exchange market through sale of dollars. Over the last 7 months, the forex reserves have fallen from $647 billion to $561 billion on account of RBI interventions. RBI governor has justified this on the grounds that the signals given were instrumental in preventing free fall of the Rupee. 

To understand the anchoring of RBI intervention, one needs to look at the inflation expectations. The RBI has maintained a consistently hawkish stance. The idea was that once the inflation expectations are managed, then the inflation expectations come down and once that comes down then the actual inflation also comes down, to the extent it is driven by consumption. The risk is that if people expect high inflation, they tend to go slow on spending and that converts the macro situation into a slowdown.

Now the RBI is applying a similar argument to the rupee intervention. Das has pointed out that the RBI defending the rupee at key levels, reduces the expectations and that avoids too much of speculation on the Indian rupee. Today, there is a strong offshore market where the rupee is traded via NDFs or non-deliverable forwards. Once the RBI sends out the signal that it is anchoring the rupee depreciation expectations, it automatically cuts down the pernicious speculation in the rupee. In short, intervention hits two birds with one stone.

Das is actually on the mark. For a country which still imports 85% of its daily crude oil needs, the rupee vulnerability is a big problem. The hardening of the dollar index has only worsened things. The RBI has its limitations since intervention has a cost. Like in the case of inflation, the RBI is gradually shifting the narrative to management of expectations. That may be the right approach and also the smarter approach to the current situation.