Misguided rhetoric on rupee: Clearing doubts on depreciation, RBI action

Rip Van Winkle, the protagonist of Washington Irving’s short story, “Rip Van Winkle”, was a native Dutch American often at loggerheads with his estranged wife, over time having inculcated a rewarding habit of avoiding useful works. Wandering to Catskill mountains one day, accompanied by his dog Wolf, Van Winkle discovers a thunderous party underway and immediately helps himself with free drinks and falls asleep, only to awaken a good 20 years later. Rip Van strolls back to the village and adapts himself quickly with a new transformed world and declares himself a loyal subject of King George III, unaware of the tectonic event that happened in the intermittent period — the American Independence.

 

Fast forward to the present. There are some Rip Van Winkles who are still 20 years behind in understanding the recent upheavals in the foreign exchange market. Such Van Winkles, apart from castigating the fall in the rupee’s value, have been even espousing a lack of wisdom on the part of the regulator in protecting the value of the rupee. Damned if you do, damned if you don’t! 

It is thus important to clear some conceptual misgivings about the recent depreciation in the value of the rupee and, more specifically, the guesses and analyses about the regulatory action by the Reserve Bank of India (RBI). 

Firstly, there has been a plethora of articles in the public domain literally castigating the RBI for holding back the rupee on a tight leash for a considerable period of time. 

Let us look at the data. We find out technically that there was a regime shift in terms of movements in the value of the rupee when it crossed 80 to the dollar in August 2022. In technical terms, we call it a Markov Switching regime. 

Beginning September 2022, the rupee weakened by 5.7 per cent on a cumulative basis till October 2024. From November 2024, when the US election results were declared, the rupee depreciated by 3 per cent till mid-January 2025. In 2016, the rupee depreciated by around 2 per cent from when Donald Trump took over in the US till January 2017, only to appreciate by a massive 5.5 per cent from January 2017 till May 2017. 

Thus, by no stretch of imagination can one argue that the rupee was not allowed to depreciate by the RBI in the last couple of years. Also, after the US Federal Reserve started raising rates in 2022, the recent depreciation is in complete consonance with what had happened earlier in 2016. As the dust settles down from January 20, past evidence does suggest a recovery in the value of the rupee. 

Secondly, as a logical corollary, the foreign exchange market intervention by the RBI has drained out liquidity and this claim has been made repeatedly. Let us look at the data for the RBI’s intervention in the spot dollar market more dispassionately.

For the two-year period ended FY24, when the rupee depreciated by a sharp 9.9 per cent on a cumulative basis, there was actually an injection of rupee resources of Rs 1.2 trillion on a cumulative basis and not any withdrawal. In FY25, the liquidity withdrawal is around Rs 1.4 trillion on average (changes in foreign exchange reserves are used from November 2024, as RBI intervention data is available only till October 2024). Thus, clearly the impact of the RBI intervention in the foreign exchange market had no outsized impact on liquidity as some observers would have us believe. 

However, there is one interesting aspect which did impact the liquidity, on which the RBI has no control: A movement in government cash balances. From a positive impact of Rs 1.4 trillion in FY23, government cash balance withdrawal/not spending were at Rs 3.7 trillion during FY24 and FY25. Such a large fluctuation in government cash balances (to the magnitude of Rs 5.1 trillion — from Rs 1.4 trillion drawdown to Rs 3.7 trillion buildup) impacted the liquidity enormously. To be fair to the RBI, no amount of liquidity management or forecasting could have solved this conundrum. 

Thirdly, the repeated argument that the current weakening of the rupee is not in consonance with the macro fundamentals. Not really! 

As a matter of fact, the dollar has strengthened against almost all currencies around the world beginning November 2024 after the declaration of the US election results. Till mid-January, the rupee has depreciated by 3.0 per cent against the dollar — still the least when compared with other countries. 

In the most recent period since March 2021, the movements in the rupee and dollar index have been mostly synchronous (17.5 per cent depreciation for the rupee and 17.9 per cent appreciation of the dollar index), indicating that the strengthening of the dollar index was driving the rupee’s depreciation. The other good thing is that around two-thirds of the external commercial borrowings are now hedged, indicating recent gyrations in the rupee value has more to do with the dollar index. 

If we juxtapose this with what was happening after the global financial crisis beginning January 2008 till May 2014, when the rupee depreciated by a whopping 48.7 per cent, completely in non-sync with the dollar index’s appreciation of only 5.2 per cent. The rupee has been allowed to depreciate against the Greenback in a calibrated manner and has lost about 20 per cent of its value since mid-2021, but it has not gyrated or tangoed like many other currencies left on their own. There lies the wisdom and forbearance of the RBI. 

Fourthly, the RBI intervention in the offshore non-deliverable forward (NDF) market, which has the benefit of not impacting the rupee liquidity, has also been questioned. Let us look at this argument more closely. 

Trading in foreign exchange markets averaged $7.5 trillion a day in April 2022 (half of it was in forex swaps) according to the BIS Triennial Central Bank Survey; the latest numbers (due this April) should hover around $8.5-9 trillion per day. These developments were driven in large part by a greater use of FX swaps for managing funding and greater electronification of customer trading, also leading to further concentration of trading in a few financial hubs. 

Interestingly, in the global forex markets, the composition of trading in many emerging market economy (EME) currencies has largely converged with that in advanced economy (AE) currencies along one important dimension: The participation of non-residents (BIS). This share has since progressively increased. By 2022, forex trading in all but a handful of EME currencies was overwhelmingly with counterparties abroad. At the same time, EME currencies attracted a wider range of participants and saw a rapid increase in offshore trading activity. Most importantly, offshore markets have tended to drive onshore markets during times of global market stress (BIS). 

Against these backdrops, it is not right to question the wisdom of the RBI intervening in the NDF markets, in particular when the offshore markets tend to drive onshore markets during times of market stress, as EME currencies are getting internationalised through increased participation of non-residents while trading activities remain largely confined to select hubs overseas where market makers are large banks having little skin in the game in India. 

As with any futures & options transaction, the transfer of risk would have to be offset with monetary compensation by any of the counterparty, but given that the slide in the rupee is quite low compared to many other currencies, from developed market to emerging market pack, weaving lofty calculations like the RBI losing 10 per cent on a $70 billion position looks far-fetched.

Fifthly, the argument that outstanding External Commercial Borrowings jumped from August 2022 and hence the exchange rate was deliberately kept stable to keep borrowing costs low does not hold water as (a) ECB registrations amount show that in 2019 the amount was $50 billion and in 2024 it has touched $46 billion till Nov, not even the pre-pandemic level (b) Unhedged ECB loans have significantly reduced to 34.4 per cent in September 2024 from 45.5 per cent in September 2022 and (c) As we noticed, the rupee depreciated by 9.9 per cent cumulatively during FY23-FY22 and there was a regime change in August 2022. Clearly, drawing an analogy, statistical average/data could hide more things than it reveals.   

Summing up, it is thus prudent not to “guesstimate” and conclude that the new RBI Governor has now become more comfortable with a depreciating rupee. For the record, in an inflation-targeting regime, interest rates are not used as a line of defence to protect the rupee, as was evident in 2018 too. 

The author is a member of the Sixteenth Finance Commission and group chief economic advisor, State Bank of India. The author thanks Ashish Kumar for his valuable inputs. Views are personal