Domestic, global headwinds challenge Indian central bank's forex intervention

The Reserve Bank of India's efforts to slow the rupee's decline have been relentless but its already-stretched strategy is now challenged by weak economic growth, tepid foreign inflows and a buoyant dollar's threat to Asian currencies, especially the Chinese yuan.

The dollar index has rallied more than 3% since Donald Trump won the U.S. presidential election on Nov. 5. The rupee has declined just 0.8% in that time, making it the second-best among major Asian currencies, largely due to the RBI's intervention.

This intervention has stretched across segments: buying and selling dollars in the onshore spot and forward markets, taking positions in local currency futures and in the non-deliverable forward (NDF) market.


"The amount of intervention has been quite substantial ... We can say intervention is a little bit stretched but, at the same time, it is a call that the RBI must take," said B Prasanna, head of global markets at ICICI Bank.

The strain is showing.

For instance, in the NDF market, the RBI's go-to strategy, the central bank's position has ballooned to levels that make it difficult to use as frequently.

Moreover, India's forex reserves are at a five-month low after the RBI sold $38 billion, per IDFC FIRST Bank's estimate, between October and the first week of December.

Investors are taking notice.

The RBI's forex policy and the rupee's future were key discussion points in a recent Asia investment tour, said Madhavi Arora, chief economist at Emkay Global Financial Services, which conducted the tour.

"With continuing pressure on the currency and policy defences arming up against the global tide, most investors believe that the RBI has stretched too far."

CHANGING LOCAL, GLOBAL CONDITIONS

The rupee hit an all-time low of 84.88 per dollar on Thursday. But for two years, it has been the least volatile Asian currency, barring the pegged Hong Kong dollar.

However, that could change given local and global challenges.

At home, economic growth hit a seven-quarter low recently, which led to foreign investors withdrawing from the equity markets and rising expectations of an interest rate cut sooner rather than later.

Globally, Trump has vowed to slap additional tariffs on China, India's largest trading partner, and Chinese policymakers may look to counter by weakening the yuan, Reuters has reported.

The yuan has declined 2.6% since Trump's election victory, prompting traders to question whether the RBI would let the rupee weaken in line to prevent an overvaluation.

The yuan is "always on the RBI's radar and it is one of the peer currencies that really matters," a person familiar with the central bank's thinking said, declining to be named as they are not authorised to speak to the media.

The RBI did not immediately respond to an email seeking comment.

"With significant volatility possible in the coming quarters -- not just due to U.S. policies but also second-order effects, say due to a bigger-than-expected move in the CNY -- the INR is likely to become more volatile," Neelkanth Mishra, chief economist at Axis Bank, said in a note.