Rbi should let the market decide the fate of the rupee

Rbi should let the market decide the fate of the rupee

With the US Fed continuing to tighten, the rupee will be under pressure. Even with the RBI unlikely to stop intervening in currency markets, considering the scale and speed of the drawdown of its reserves, the central bank should be circumspect about how it proceeds.

Last week, the US Federal Reserve raised the benchmark federal funds rate by 75 basis points for the third straight time. While this was expected, the tone of the policy was markedly hawkish as the Fed sought to underline its commitment to tackle inflation, which remains well above target. The central bank signalled significantly higher rates than was widely anticipated, dousing expectations of policy rates being eased next year. This unexpectedly hawkish commentary roiled global markets. The effects were felt across asset classes, and markets.

With the Fed tightening aggressively, the dollar has strengthened, and currencies of both developed and emerging economies have come under pressure. The DXY, the dollar index, has surged — it is currently trading upwards of 113, up more than 16 per cent since the beginning of the calendar year. The euro has fallen to a new 20-year low as elevated inflation, a persisting energy crisis, and the slow pace of rate hikes are weighing down the currency. The sterling has also fallen, declining by almost 5 per cent on Monday alone to an all-time low after the new government, headed by Liz Truss, announced new fiscal measures. The yen is also facing pressure. Late last week, with the currency plunging to a 24-year low, hovering around the key level of 145 against the dollar, Japan intervened in the markets for the first time since 1998 to strengthen the currency. China has also unveiled measures to increase the costs of betting against the yuan using derivatives.

Until recently, the Reserve Bank of India had been actively intervening in the currency markets. The central bank’s foreign exchange reserves have fallen by around $90 billion over the past year, providing some sense of the extent of its intervention. Worryingly, the pace of intervention had gathered steam over the past few months. However, after the recent US Fed meeting which signalled its hawkish stance, there are indications that the central bank has slowed the pace of its interventions. After hovering around the psychological mark of 80 against the dollar till now, the rupee has breached this level — on Tuesday, the currency ended the day at 81.58 against the dollar. But considering the extent of tightening the Fed envisages over the coming months, the pressure on the rupee is unlikely to subside. The inflationary implications of a weaker currency are likely to weigh on the members of the monetary policy committee when they meet over the next few days, complicating matters. But even as the RBI is unlikely to stop intervening in currency markets, considering the scale and speed of the drawdown of its reserves, the central bank should be circumspect about how it proceeds as the global economic environment becomes increasingly challenging. It should allow the rupee to adjust to market realities.