Rupee Spurts, Bond Yields Fall On RBI Intervention
A comment from the RBI on Monday signaled that the central bank may be comfortable with a stronger rupee.
The Indian rupee opened higher and bond yields fell sharply after the Reserve Bank of India stepped in with steps to keep market interest rates in check and gave a rare signal that it may be comfortable with a stronger currency. The measures were announced on Monday after a two-week period in which inflation fears and concerns over fiscal slippage pushed up yields.
The rupee jumped nearly a percent to trade above 73 against the U.S. dollar in morning trade. A weaker dollar index, trading at near two-year lows, also pushed the rupee higher. The rupee has appreciated by around 2.5% over the past week after trading in a narrow band around the 75 per dollar level since the Covid-19 crisis broke out.
The 10-year benchmark bond yield fell 17 basis points to trade at 5.94% in morning deals. The rupee also appreciated 0.7% after the Reserve Bank of India signaled its comfort with a stronger currency, which helps keep imported inflation in check.
On Monday, the RBI announced a series of steps to calm the bond markets, including special open market operations and variable rate term repo auctions. It also allowed banks to hold more bonds under the held-to-maturity bucket.
“The announcement of more Operation Twist and HTM limit increase goes to show that the central bank remains determined to keep longer duration bond yields from inching up sharply, as it would have hampered monetary transmission and delayed the ongoing recovery in the economy,”said Kaushik Das, chief India economist at Deutsche Bank.
Comfort With A Stronger Rupee
The central bank also tried to calm inflation fears by saying that food and fuel prices are stabilising and cost push factors are moderating. “In addition, the recent appreciation of the rupee is working towards containing imported inflationary pressures,” the central bank said, making a rare reference to the currency in relation to inflation.
The comment prompted currency watchers to question whether the central bank is now comfortable with a stronger rupee. Over the last three months, it has absorbed much of the foreign inflows to build reserves and prevent any sudden volatility in the currency.
“The RBI statement links this move in dollar-rupee to the RBI potentially creating additional elbow room for intervention in bond markets. In the past, the RBI has avoided directly linking its currency market spot intervention with its inflation and monetary objectives,” wrote Ananth Narayan, senior India analyst at the Observatory Group.
Narayan said the RBI may still be wary of any deep, durable outperformance of the rupee against its trading partners. “Instead, we conjecture that the RBI would at best prefer a step reset lower in dollar-rupee, in line with the ongoing global movements in the U.S. dollar and the Chinese yuan,” Narayan said.
Suyash Choudhary, head of fixed income at IDFC Mutual Fund, agreed.
The central bank seems to have gone somewhat light touch in absorbing incoming dollars lately, leading to an almost 2% appreciation in the rupee over the last fortnight, Choudhary wrote in a note on Monday. “Basis the statement, it now appears that the RBI has selected this as the more effective tool to address aspects of the current inflationary episode, while ensuring that monetary policy tools continue working towards mitigating the growth risks.”
The Indian economy is likely to report a balance of payments surplus in FY21. Against that backdrop, the RBI is confronted with two policy options, said Madhavi Arora, economist at Edelweiss. The RBI can either intervene both in spot and forward markets to absorb the surplus emanating both from current and capital account side and build reserves or simply take a back seat and let the rupee appreciate. “Barring the last week, RBI in so far has chosen the former, signaling it is possibly correcting for Real Effective Exchange Rate overvaluation,” Arora said.
On a real effective exchange rate basis, the rupee still appears overvalued by about 7% compared to its long-term average, Arora explained. The REER is a measure of the rupee against a basket of currencies across trading partners, adjusted for inflation.