Notwithstanding the over 7% depreciation of the Indian rupee against the US dollar, the Reserve Bank of India (RBI) has decided to ensure that the rupee finds its level in an orderly evolution, but it would have zero tolerance for volatile and bumpy movements..
“We will continue to engage with the forex market and ensure that the rupee finds its level in line with its fundamentals,” RBI Governor Shaktikanta Das said on July 22, 2022.
“I would like to reiterate that we have no particular level of the rupee in mind, but we would like to ensure its orderly evolution and we have zero tolerance for volatile and bumpy movements,” he said while addressing the annual banking conference of Bank of Baroda in Mumbai.
He said due to the RBI actions, including measures to encourage inflows, the movements of the rupee had been relatively smooth and orderly
“By eschewing sudden and volatile shifts, we have ensured that expectations remain anchored and the forex market functions in a stable and liquid manner,” he added.
Stating that the recent developments in the forex market have generated intense debate, including predictions of the rupee dropping to record lows, Mr. Das said it was important to recognise that spillovers from the global monetary policy tightening, the geopolitical situation, the still elevated commodity prices — especially crude — and the lingering effects of the pandemic, all coming together, have become overwhelming for all countries the world over.
“Even reserve currencies such as the Japanese yen, the Euro, and the British pound sterling have not been spared. Portfolio funds are selling off assets and fleeing to safe havens. Merging market economies (EMEs) are particularly affected by capital outflows, currency depreciations and reserve drawdowns, complicating macroeconomic management in these countries,” he said.
Mr Das said the impact of these overwhelming spillovers on India had been relatively modest.
“In fact, the Indian rupee is holding up well relative to both Advanced and EME peers. This is because our underlying fundamentals are strong, resilient and intact,” he said.
Emphasising that the recovery was gradually strengthening, he said “current account deficit is modest. Inflation is stabilising. The financial sector is well-capitalised and sound. The external debt to GDP ratio is declining. The foreign exchange reserves are adequate.”
The governor said in recognition of the fact that there was a genuine shortfall of supply of forex in the market relative to demand because of import and debt servicing requirements and portfolio outflows, the RBI had been supplying US dollars to the market to ensure that there was adequate forex liquidity.
“After all, this is the very purpose for which we had accumulated reserves when the capital inflows were strong. And, may I add, you buy an umbrella to use it when it rains!” he said.
Highlighting that a predominant part of the outstanding ECBs is effectively hedged, he said according to the June 2022 Financial Stability Report (FSR) of the RBI, of the outstanding ECBs of US $ 180 billion, 44 per cent or US $ 79 billion is unhedged.
This includes about $40 billion liabilities of public sector companies — mainly in the petroleum, railways and power sectors — which have assets with a natural hedge character. Besides, being public sector entities, their foreign exchange risk — if any — can be absorbed by the government, Mr Das said..
“The remaining $ 39 billion ECB represents 22% of the total ECBs outstanding. Even this includes borrowings of those companies which have a natural hedge, i.e. earnings in foreign currencies. This would leave a very small portion of the total outstanding ECBs that are truly unhedged,” he said.
“Corporate entities eventually face a trade-off: if they hedge their forex exposure completely, the cost of borrowing goes up and the advantage of cheaper borrowing in foreign currency is lost. On the other hand, to the extent they do not hedge, debt servicing can go up when the exchange rate is under pressure,” he added.
This has led to the concept of the optimal hedge ratio which calculates the proportion of hedging that minimises the variance of the portfolio.
“For India, our internal research estimates the optimal hedging ratio at 63 per cent. Taking into account natural hedges and the exposure of public sector companies, the optimal hedge ratio condition is comfortably satisfied in the case of the stock of ECBs in India’s external debt,” he explained.
