Does The Strong Rupee Reflect A Shift In Policy Or A Lack Of Options?
Comments from the commerce minister and limited RBI intervention raises questions about a shift in thinking on rupee.
The Indian rupee has appreciated nearly 6 percent in the first four months of the current year. The 4.7 percent gain seen in the January-March quarter was the best in 19 quarters. In fact fiscal year 2016-17 was the first in five years that the Indian currency did not depreciate.
Typically, such an appreciation has the Reserve Bank of India (RBI) intervening heavily and the government worrying about the impact of a strong rupee on exports. As recently as September 2016, CNBC-TV18 reported that Commerce Minister Nirmala Sitharaman had called for a devaluation in the rupee to support exports. The reports were later denied by the finance ministry and the commerce ministry. At the time, the rupee stood at 67 against the U.S. dollar.
In contrast, today, when the rupee is at 64.51 against the U.S. dollar, Sitharaman downplayed concerns around a strong currency and was quoted as saying that a strong rupee is a reflection of a strong economy.
“…Although strengthening of the rupee by itself will be worrying today I will contextualise it in the Indian economy’s overall strengthening position,” Commerce Minister Sitharaman said according to a report published in Mint newspaper on Monday.
The statement, combined with anecdotal evidence of relatively limited intervention by the RBI in the forex markets, has led to speculation on whether authorities have moved to a ‘strong rupee’ policy. This, in turn, could keep the rupee less rangebound than in the past, wrote Edelweiss Research in a report dated April 18.
Economists, however, are not convinced that there has been an explicit shift in the government or the RBI’s thinking. They point to limited options to curb strength in the rupee at a time when the country has received more than $13 billion in fund flows in less than four months.
I don’t think India is explicitly moving towards a stronger rupee policy, Abheek Barua, chief economist at HDFC Bank told BloombergQuint.
There are two issues, the capital flows have been very strong and you also had excess liquidity. The commerce minister’s comments are sort of acceptance of the fact that there is a limit to which you can manage the rupee.Abheek Barua, Chief Economist, HDFC Bank
Barua, however, acknowledged that the RBI has been intervening less aggressively as compared to earlier. “So, there seems to be some change in stance,” Barua said while adding this could also be because of the costs attached to sterilising large forex inflows at a time when there is surplus liquidity in the domestic market.
Bimal Jalan, former governor of the Reserve Bank of India (RBI), took a similar view and noted that the strength in the currency is a consequence of accelerated capital flows.
“Growth is high, inflation is under control...by and large it is a positive indicator for the rest of the world. Inflows from foreign investors have accelerated and Indian stock market is doing very well. This shows confidence in India's economy,” Jalan told BloombergQuint over the phone.
A Strong Rupee For Inflation Control?
One possible reason for authorities to not balk at a strong rupee right now is the inflation scenario. After a dip to below 4 percent in fiscal 2016-17, retail inflation is set to increase to between 4-5 percent in the current fiscal. This, assuming, that commodity prices remain moderate. If commodity prices rise, on the back on a strong global economy, upside risks to inflation could increase.
Can a stronger currency take the bite out of the imported inflation?
Sonal Varma notes that the rupee appreciation since the state elections has led to questions on whether there has been a change in stance, but doesn't believe this is linked to inflation.
Given CPI is largely a non-tradables basket (food and services) the exchange rate pass-through to inflation is quite limited. So I doubt the change in stance is to manage inflation.Sonal Varma, Chief India Economist, Nomura
In its monetary policy report released in April, the RBI said that a 5 percent appreciation in the rupee leads to a 10-15 basis point (bps) decline in headline inflation.
“Perhaps the RBI will be more permissive of forex appreciation as a disinflationary tool. We would, however, be surprised if the RBI were to use the forex to curb inflation, given that the estimated first-round elasticities according to the RBI are very low,” wrote Sajjid Chinoy, chief Asia economist at JPMorgan in a report on March 22.
Barua’s view is that while there are some inflation benefits that may emerge from a stronger rupee, an overvalued currency can be a bigger danger than inflation.
Think concerns about the fair value become very critical and not just from an export perspective but an overvalued currency being punished at some point by investors. So you might have a currency depreciation-led run on the capital account.Abheek Barua, Chief Economist, HDFC Bank
The REER Argument
The fears of overvaluation in the currency emerge from the real effective exchange rate (REER) of the currency.
The 36-country REER index in March stood at 117.67 compared to 115.67 in February, shows monthly data released by the RBI. A value higher than 100 suggests overvaluation in the currency. At current levels, the REER index is at a historic high, which some fear could impact competitiveness, particularly in the export sector.
“…The resultant appreciation of the real effective exchange rate (REER) will lead to reduced competitiveness and slower recovery of organised sectors suffering from low capacity utilisation,” Arvind Virmani, former chief economic adviser to the Government of India told BloombergQuint in an email.
Soumya Kanti Ghosh, chief economist at SBI raised another concern around an overvalued currency. When the rupee appears to be on a consistently strengthening path, hedging activity tends to drop, he said. This, in turn, can leave the corporate sector vulnerable if a global risk-off environment leads to an abrupt reversal in the direction of the currency.
“No central bank may not want to caught off guard considering all such factors and hence it is difficult to say whether the preference by RBI is for nominal exchange rate targeting,” Ghosh told BloombergQuint.
