When money is the best inflation moat

On the list of items sterilized by the hour in Covid-ravaged India, the rupee features as prominently as do ICUs, oxygen units, isolation centres or medical equipment. And we must thank a committed set of 24X7 frontline warriors at Mint Road for helping sterilize the impact of violent fund flows, building a glide path for the local currency to balance the conflicting needs of all primary stakeholders.

At 72.74 to the dollar, the rupee has climbed nearly 4 per cent from its recent lows reached April 20, when the second Covid wave engulfed New Delhi and Mumbai, shuttering India’s economic nerve-centres in a macabre display of morbidity that would have unnerved even diehard optimists. As Covid cornered more column inches and airwaves through a forgettable start to the new financial year, foreign portfolio investors (FPI) began unloading Indian stocks – for the first time in seven months.

Yet, the rupee hasn’t panicked.


Rather, it has begun a difficult climb back from the 75.5 base-camp through a period that coincided with localized mobility curbs, business restrictions, chaotic demands for hospital beds, and innumerable complaints of inadequate jabs.

Bane or Boon?
In fact, the rapidity of the movement has stoked concerns whether the 4 per cent advance for the local unit in less than six weeks could blunt India’s export edge, especially when low global trade volumes tilt the game decisively in favour of alternative destinations that are ostensibly more currency competitive.

But an analysis of the texture of India’s merchandise exports and the industry structure of services outsourcing should soothe such concerns. Rather, a stable currency with a slightly appreciating bias might just serve India better at this juncture, with most commodities in some stage of what is being called a resources super-cycle. It would help negate the risks of imported inflation in a country that depends on overseas crude oil to move men and materials - and gold to add sheen to the now familiar big, fat weddings.

“By intervening in the forwards over the last few sessions, the Reserve Bank of India (RBI) has also created elbow room to absorb more inflows,” India Forex Advisors said in a recent report.

To be sure, concerns about export competitiveness fail to factor in the pre-Covid levels of the local unit. Before India began the first lockdown late March last year, the rupee averaged 71.29 and 71.49, respectively, to the dollar in January and February of 2020, showed a study by SBI Research. The average crashed to a low of 76.24 in April as nearly $17 billion of foreign capital ditched Indian financial assets in record outflows over two months.

A Calibrated Response
A strong correlation between overseas flows and local currency levels is evident in the analysis of the past year and a half. Overseas flows have shaped the direction of the rupee against the dollar, regardless of the local market commentary, with flows continuing in one direction for 10 consecutive months. Yet, the central bank turned net sellers in the last two months of FY21, balancing export competitiveness and mitigating the risks of imported inflation.

“The data until March showed that the rupee was allowed to appreciate and in fact, the RBI turned net sellers in the last two months of that fiscal (FY21),” SBI Research said in a report after the monetary policy last week. “The objective of the central bank is to keep the financial markets stable, as is clear through its two-sided interventions in the spot, forwards, and futures markets.”

Currency management will be of greater significance after the RBI lowered FY22 growth projections last week to 9.5 per cent, even as the threat of inflation seems inevitable due to the surge in crude oil prices, and a likely return to normalcy in most parts of the West through the holiday season.

Finally, will a slightly appreciating rupee hit India’s exports? That’s unlikely. India’s merchandise exports – of refined petroleum, jewellery, pharma, or cars - have significant import components. Hence, rapid depreciation of the local unit actually inflates input costs, potentially reducing the headroom when re-exporting.

Separately, the competitiveness of software, services and BPM exports does not depend as much on currency as on scale and capabilities. Services outsourcing is premised on long-term contracts and India is the undisputed global leader in this industry that makes up a tenth of the GDP.

That’s a moat few have the capability to build.