RBI must not just guard the rupee, Pg13

Key Highlights:

• The Reserve Bank of India (RBI) is grappling with managing inflationary pressures and the depreciation of the Indian rupee.
• The rupee's depreciation is influenced by the broad appreciation of the US dollar against various currencies globally.
• Net capital flows, particularly portfolio flows, are a primary driver of exchange rate movements.
• The RBI has strategically intervened in the rupee market, focusing on managing volatility rather than committing to a specific price.
• Measures taken by the RBI include liberalizing Foreign Currency Non-Resident (FCNR) deposits and opening up foreign investments in government securities through the Fully Accessible Route (FAR).

Detailed Insights:

• Trade in goods and services accounts for 45.8% of India's GDP, making the exchange rate crucial for domestic growth.
• Global investors became more risk-averse, preferring the United States as a safer investment destination, leading to capital outflows from India.
• The RBI bore almost all hedging costs for FCNR deposits to attract inflows, reportedly drawing $17.4 billion in early months.
• The maturity of these FCNR deposits in two to three years poses a potential risk of rupee reversal, similar to the 2016 experience.
• Foreign Portfolio Investors (FPIs) purchased debt worth ₹21,652 crore under FAR in June, indicating some success in attracting long-term debt investments.
• The RBI has been a net seller of dollars through forward contracts since October 2023, which markets interpret as a weak outlook for the rupee.
• The RBI also limited domestic participation in Non-Deliverable Forwards (NDFs) to address speculative forces, a move perceived unfavorably by some.

Key Concepts Involved:

• Foreign Currency Non-Resident (FCNR) deposits: Term deposits held by non-resident Indians in foreign currency, offering protection against exchange rate fluctuations.
• Fully Accessible Route (FAR): A scheme introduced by the RBI allowing non-residents to invest in specified government securities without any restrictions.
• Taper Tantrum: The 2013 financial crisis triggered by the US Federal Reserve's announcement of reducing its quantitative easing program, leading to capital outflows from emerging markets.
• Non-Deliverable Forwards (NDFs): Cash-settled short-term forward contracts on thinly traded or non-convertible currencies, used for hedging or speculation.