Despite Moody's rating downgrade, indicators point to rupee revival

Despite a sovereign rating downgrade by Moody’s, the rupee strengthened, and bond yields fell as markets shrugged off the downgrade.

Currency dealers say the Reserve Bank of India (RBI) intervened in the currency markets, and may have even bought some bonds anonymously from the secondary markets.

For now, it seems that the Reserve Bank of India (RBI) is not letting the rupee appreciate. The central bank is soaking up all the inflows coming due to stake sales in Reliance Jio and Bharti Airtel. In the week ended May 22, the RBI added $3 billion in its kitty to take the forex reserve to a record high of $490 billion. 

If the central bank did not absorb the flows, rupee would have appreciated from its present level of 75.36 a dollar. Rupee had closed at 75.54 a dollar on Monday before the rating downgrade. 

The 10-year bond yields closed at 5.79 per cent, down from its previous close of 5.82 per cent.

Interestingly, even as rupee seems to be overvalued vis-à-vis its export competitors in a 36 currency basket, taking 2004-05 as base year, rupee seems to be way undervalued against six major global currencies, taking the base year as 2017-18 a newly revised calculation for real effective exchange rate (REER). The 36-currency basket using 2017-18 as the base year has not been disclosed publicly. REER measures a currency’s relative strength against other currencies that it trades with. 

The REER value as on April, taking 2017-18 as the base year, was 92.10 in the six-currency basket. Taking 2004-05 as the base for the same six-currency basket, however, rupee’s REER is 118.98. If 100 is considered fair value, anything more than 100 is overvaluation, and less than 100 is undervaluation. So, with the change of base year, rupee’s relative position gives conflicting signals. 

Taking into account the 36-currency basket, rupee’s REER is 113.48 for the base year 2004-05. As mentioned earlier, there is no 36-currency basket REER taking 2017-18 as base. If there was, it is likely that rupee would have reflected an undervaluation.   

This 92 level of REER technically means that against the dollar, rupee should appreciate, provided of course, the central bank lets it to be. 

For now, though, currency dealers don’t believe rupee will be allowed to appreciate much. 

“A REER value of 92 means rupee is extremely weak and may become strong, but that is unlikely to happen, at least for now,” said Abhishek Goenka, managing director and CEO of IFA Global.

According to Rahul Gupta, Head of Research- Currency at Emkay Global Financial Services, the REER at 92 doesn’t imply much. 

“The REER is in relation to other currencies. If the rupee continues to trade above 75, and other currencies move, then REER will automatically adjust to 95-96 zone. It is not necessarily that rupee will have to appreciate,” Gupta said. 

“At every level, the RBI is intervening, as can be gauged by the rising reserves. That may imply that the RBI is holding the rupee around 75-75.5 zone. Even on technical grounds, 75.10 is a very important level. Unless it is breaching that level, rupee may continue to depreciate. Once it goes to 76, it can breach its all time low of 79.90 too, Gupta said.

Goenka expects rupee to remain range-bound between 74.50 and 76 a dollar.

However, in the long term, there are chances that rupee would appreciate. Once the global economy recovers from the Covid-19 related dislocations, it is possible that the inflows in India will increase substantially, considering the global liquidity conditions remain ease. 

Besides, many companies could wind up from China and India is one of the lucrative alternatives, which will bring substantial foreign currency flows in the country, and the rupee could strengthen substantially, experts say.