Rupee to see volatility, but no huge slide if Fed tapers in Nov: Experts

Unlike 2013, this time the taper has been communicated well in advance and RBI is ready for any challenge due to huge build-up of forex reserves and a comfortable current account position

With the US Federal Reserve expected to taper its monthly $120 billion bond purchase programme from November, the easy money policy is technically ending, even as other developed economies continue for some more time.  

The Federal Open Market Committee (FOMC) will meet for two days starting Tuesday to decide whether and by how much they reduce their bond purchases. Senior officials have indicated taper, and the market is sure about it, but weak growth concerns may end up delaying it.  

The US Fed taper will have ramifications for the emerging markets, and India is not immune to that. However, unlike 2013, this time the taper has been well communicated in advance and the Reserve Bank of India (RBI) is prepared to face any adverse challenge, thanks to the huge build-up of foreign exchange reserves and a comfortable current account (deficit at 1 per cent of GDP) position, experts say.  

“With the current account deficit in a comfortable situation and an extremely unlikely devastating third COVID, the Indian rupee is going to handle any taper news with relative calm,” said Soumya Kanti Ghosh, group chief economic advisor at State Bank of India.  

India’s external position is in “significantly better shape than in 2013,” and the potential Fed taper is “unlikely to exert any serious and sustained pressure on the rupee,” noted BofA Global Research in a recent note.  

Back in 2013, the taper news led the rupee to slide about 15 per cent between May and August, leading the RBI to raise short-term rates by 200 basis points, sending the bond market in a tizzy and pushing short-term yields up by 300 basis points. In 2013, India’s CAD was at 4.8 per cent of the GDP, and the import cover was just for seven months with a reserve of $300 billion.  

The rupee had finally stabilised after newly appointed RBI governor Raghuram Rajan raised more than $30 billion through foreign currency deposits and bonds.  

BofA and SBI estimate India’s FY-22 CAD at 1.3-1.4 per cent of GDP, while RBI’s import cover is over 15 months. The reserves, as a percentage of GDP, now stand at 22 per cent compared with 15 per cent in 2013.  

Current RBI governor Shaktikanta Das believes reserves to be the best insurance for volatility caused by developed country policies. Das took the foreign exchange reserves to $641 billion, including the recent $17.86 Special Drawing Rights by the International Monetary Fund (IMF), from $455 billion in December 2018. Such aggressive reserve accumulation has put India on the US currency manipulator watch list twice, while the IMF recently said the RBI should not aggressively intervene in the currency market.  

The rupee closed at 74.88 on Friday, marking the end of October, compared with its Thursday’s close of 74.92. The rupee has seen frequent two-way movements in October, falling on rising crude prices, and balanced by inflows of initial public offerings.  

The secondary market, though, has witnessed some sell-off. Foreign portfolio investors (FPIs) have intensified their selling in the secondary market over the past fortnight. Since October 20, they have yanked out nearly Rs 22,000 crore from domestic equities. The selloff comes amid a series of downgrades by foreign brokerages on concerns over India’s record-high valuations.  

Typically, such selling weighs on the rupee. However, experts this time around the selloff on account of large public floats by companies such as Nykaa (size Rs 5,300 crore), PolicyBazaar (Rs 5,600 crore) and Paytm (Rs 18,300 crore). FPIs are expected to be large participants in the IPOs of these startups.  

“Three IPOs alone are expected to raise Rs 30.000 crore from the market over the next few days. These IPOs are expected to get heavily oversubscribed and therefore there will be a huge drain of money from the secondary to the primary market. This is another factor prompting FPIs to sell,” said VK Vijayakumar, Chief Investment Strategist at Geojit Financial Services.  

The rupee was at 73.09 per dollar as of September 1 and fell to 75.52 on October 12. The rupee is now below 75 again, but can again give up gain.  

Overall, the Indian rupee has been the weakest in the region in October, losing 0.9 per cent against the dollar.  

On a Real Effective Exchange Rate (REER) basis, the rupee reflects overvaluation. Based on REER, which measure’s rupee’s strength against its trade partners and export competitors, the currency’s value should be close to 78 a dollar, but RBI may not want to see that. Weak rupee fans imported inflation, particularly when the crude prices are on the ascent.  

Ghosh of SBI said considering an excess supply of dollars at $2.2 billion in August, appreciating bias on rupee remains.  

“Considering higher domestic inflation, as supply disruptions mount, it will not do any harm for RBI to lean with the wind and let rupee appreciate as it can lead to reduced imported inflation when metal and oil prices are rising, and clearing the liquidity overhang to some extent,” Ghosh said.  

There could be volatility after the US Fed lowers its bond purchase programme.  

“A steady increase in oil demand due to economies recovering and supply chain-related issues have pushed up energy prices steeply. Rising oil prices will continue to increase risks of intensifying inflationary fears and widening trade deficits in India and will weigh on the rupee,” said Sriram Iyer, senior research analyst at Reliance Securities.  

If everything remains as expected, the rupee can strengthen as much as 74.39. While breaching the 75 levels will see rupee falling as much as 75.70 levels before dollar sellers pull back the currency, according to Iyer.