Managing the rupee

RBI's currency intervention must be limited

The data released by the Reserve Bank of India (RBI) last week showed that India’s foreign-exchange reserves declined by $14.9 billion in the week ended September 18, the sharpest weekly fall since November 2024. It has also been reported that the RBI sold foreign exchange worth $10.9 billion and the rest of the decline resulted from revaluation. Net foreign-exchange sales of about $11 billion by the central bank in a week were significant, and presumably done to support the rupee, which is under pressure largely owing to the recent spike in prices of crude oil. Renewed tensions in West Asia and increased uncertainties over the ongoing conflict between the United States (US) and Iran have pushed up prices. Prices of benchmark Brent crude increased over 17 per cent over the past month.

 

Since India imports most of its crude-oil requirement, demand for foreign currencies will likely increase, putting pressure on the rupee. Foreign portfolio investment also turned negative in September after witnessing positive flows for the past three months. Thus, the pressure from both the current and capital accounts would have warranted large intervention by the RBI. This was also partly reflected in the RBI’s latest monthly bulletin, which noted that strong foreign-currency non-resident (bank) deposits, or FCNR (B), led to a recovery in early September, but the gains in the rupee were reversed later owing to higher crude oil prices. The RBI announced a swap scheme in June, including for FCNR (B), which was well received. Banks mobilised deposits worth about $133 billion under the FCNR (B) window. This helped push up foreign-exchange reserves over $785 billion in the week ended September 4. The reserves have since declined by about $20 billion.

 

The swap scheme was seen as a step towards creating a buffer, possibly to deal with extreme circumstances and fend off potential speculative attacks on the currency. It should not be used to support the currency when the fundamentals have changed, simply because no amount of reserves can defend a level. The RBI must allow the rupee to fall along with the shift in fundamentals. The rupee has depreciated by about 5.5 per cent against the dollar since the beginning of the Iran war. Higher oil prices, along with weak capital flows, will inevitably lead to currency depreciation. Although the stated policy of the RBI is that it does not target any level in the currency market and only intervenes to reduce volatility, the decline in reserves suggests it is also looking at other objectives.

 

The RBI would do well not to excessively intervene in the currency market and let the rupee fall in an orderly fashion for at least two reasons. First, there is no clarity on how long the conflict will last and the Strait of Hormuz will remain blocked. Sustained higher oil prices and global economic uncertainty could keep the rupee volatile, demanding RBI intervention from time to time. If the reserves are significantly depleted, the RBI may not be in a position to act when it is needed. Although the response to the swap scheme was encouraging, resorting to something similar again must be avoided. Second, the decline in the rupee since last year is helping exports. Despite global uncertainties, India’s merchandise exports increased 17.85 per cent during April-August this year. Higher exports will help contain the impact of increased prices of crude oil on the current account. It will also help maintain the growth momentum. An aggressive defence of the rupee will not only run down reserves faster but also deny the economy the chance to adjust to changes in fundamentals.