Indian rupee and U.S. dollar note. (Photographer: Dhiraj Singh/Bloomberg)

Rupee Fall: Should Government, RBI Intervene Or ‘Keep Calm & Carry On’?

The Prime Minister and top government officials are set to take stock of the economy on Saturday, with the fall in the Indian rupee being one of the issues up for discussion.

The rupee has fallen over 12 percent this year and is the worst performing Asian currency. However the Indian unit’s fall is not isolated. Most emerging market currencies have taken a hit this year due to a host of factors, including higher oil prices and a turn in sentiment towards emerging market assets.

Against that backdrop, experts differ on whether the government or the Reserve Bank of India need to intervene and the nature of the response needed.

Breaking The Momentum

In a conversation with BloombergQuint, Ananth Narayan, associate professor of finance at SP Jain Institute of Management and Research and a veteran of the financial markets in India, explained that while the depreciation in the rupee wasn't surprising, recent trading activity suggests some fear in the market.

“The rupee has been overvalued. Going by the 36-country Real Effective Exchange Rate it was overvalued by 21 percent as of January and therefore a correction was called for,” Narayan said in a conversation with BloombergQuint. He, however, said that currency corrections need to be over time. “The moment the pace becomes too fast, there is always a risk of a panic setting in.”

There have been some signs of nervousness in the market over the past month. The rupee, until the government announced its review meeting, was down 5 percent in just a month. The move from a level of 70/$ to nearly 73/$ also came in less than a month, leaving market participants concerned about the weakening sentiment.

This has prompted a shift in the mood. Even those who were welcoming a weaker rupee now feel that some intervention or assurance from policymakers may be needed.

Anindya Banerjee of Kotak Securities concurred.

“What we're seeing is verbal intervention. That's needed because when an emerging market currency is trading at an all-time low, there is always a chance of a panic setting in and there is speculative pressure which comes in,” Banerjee said. “That’s the reason such interventions are needed from time to time.”

A Measured Response

Should the government and the RBI choose to respond, there are a number of options starting with heavier dollar sales by the central bank.

India’s forex reserves are currently at just under $400 billion and are seen as adequate to cover over eight months of imports. “India’s forex reserves appear comfortable and it reinforces the faith in the central bank’s ability to mange excessive and unwarranted volatility in the rupee,” wrote Shubhada Rao, chief economist at Yes Bank, in a report released at the start of September.

The government, at its end, can consider policies which encourage exports and bring down imports. The RBI, in turn, can consider options to draw in more foreign exchange via easier external borrowing norms or by liberalising rules for foreign flows into the debt markets. Higher interest rates too can encourage foreign flows by providing a more lucrative interest rate differential to foreign investors.

A Stronger Response

Both Ananth Narayan and Banerjee felt that a response stronger than that isn't needed right now. However, should policymakers want to keep contingency options in place, a number of measures can be considered.

One such option could be resorting to another scheme with taps the pockets of non resident Indians. In 2013, the RBI raised $34 billion through a foreign currency non-resident (FCNR-B) deposit scheme. Prior to that, India raised $2 billion via India Millennium Deposits (2000) and another $2 billion via Resurgent India Bonds ($2 billion).

While not tried before, India can also choose to raise overseas funds via a sovereign dollar bond.

Ananth Narayan does not believe such schemes are required at this stage. “When do we need to look at options like a sovereign dollar bond? When our reserves fall to a precariously low level... We're not in that position right now.” According to him, any such scheme comes with its expenses.

Banerjee said that the time isn't right for an option like a sovereign bond since India would need to pay a higher yield against the current environment. Over the long term, a sovereign bond could make sense from a reserve management perspective, he said.

A final option would be to look at raising interest rates to defend the currency. However, since the Reserve Bank of India is now an inflation targeting central bank, it isn't clear whether the option can be used. To be sure, the MPC can choose to raise rates for the third time at its meeting in October. But even to do that, the MPC’s narrative would need to change towards macro-economic stability since the domestic growth-inflation dynamics may not warrant a rate hike, said Yes Bank’s Rao.

Watch the full interview here: