RBI Right to Calm, Not Peg, the Rupee

Pressure on the rupee is mounting as India's trade deficit widens, and portfolio investment outflow remains elevated. The market is seeking cues from the Indo-US trade deal that could impact demand for dollars on both the current and capital accounts. RBI, according to established policy, is intervening to stabilise the exchange rate rather than to defend any specific level for the rupee. The currency has lost 4.5% this year, and is expected to keep flirting with ₹90 to a dollar on month-end import demand. The dollar is strengthening on expectations of a rate cut by Fed next month. A higher frequency of RBI intervention in the forwards market is constrained by its need to replenish forex reserves.

A resolution of the tariff issue with the US will provide policy support to the rupee. Even a limited trade deal and a rollback of penal tariffs over the purchase of Russian crude will add to India's strong growth momentum. Tax stimulus for domestic consumption is offsetting the drag on exports to the US, India's biggest trading partner, and the energy market has headroom for India to switch its fuel supplies. Expectations of a breakthrough in trade talks are keeping markets on edge despite headline indices being close to their lifetime highs, and despite indications that growth during the quarter will sprint along as it did in the previous three months.

RBI is set for a meeting to review rates early next month. Growth and inflation are on course to meet the central bank's full-year projections. There is scope to cut rates, but core inflation remains elevated. The rate-setting decision will also impact the exchange rate, although Sanjay Malhotra has flagged the Indo-US trade deal as the signal for dollar demand. The external environment that is putting pressure on the rupee will guide RBI's monetary policy outcome. In any event, RBI is expected to be proactive about exchange rate management.