INR faces headwinds

by Janaki Samant

The Indian rupee has been falling steadily against the US dollar. It was at Rs.79.88 per USD on July 15 compared to an average rate of Rs.74.44 per USD in January. Recent developments point to a further depreciation of the Indian rupee against the USD.

The depreciation was rather sharp at Rs.5 in six months till July. As a result, the RBI announced a series of measures on July 6 and July 11 to stem the depreciation. But, these appear to be inadequate. We believe so because the conditions for the rupee are getting tougher even as the RBI acts. There are at least two elements of this adverse conditions.

  1. The US Federal Reserve may react with a sharper-than-expected rate hike because the June inflation rate at 9.1 per cent was higher than expected. Markets are now reported to anticipate a 100 bps rate hike compared to the earlier 75 bps. This will spur greater capital outflows from India.

    Net FII outflows from debt and equity amounted to USD 5.7 billion during the October-December 2021 quarter. This rose to net outflows of USD 15.5 billion during the January-March 2022 quarter. The outflows continued to remain high at USD 14.4 billion during the April-June 2022 quarter. It could rise further during the current and subsequent quarters.

  2. The forex drain on account of trade imbalances is much larger than the FII outflows and, it is rising. The trade deficit has risen from USD 60.1 billion in the October-December 2021 quarter and USD 54.4 billion in the January-March 2022 quarter to USD 70.3 billion during the April-June 2022 quarter. Surpluses on the services trade usually offset the trade deficit by about USD 28 billion. As per the preliminary data, net services inflows were at USD 25.6 billion in the April-June 2022 quarter. Even if this data is revised up to USD 28 billion, it will lead to an over-USD 10 billion increase in trade deficit (from goods and services) than that seen in the preceding quarters. This implies a substantial widening of the current account deficit during the quarter ended June 2022.

In March and to an extent in April, the RBI intervened with the sale of US dollars in the forex market. In March, net dollar sales by RBI were the highest-ever at USD 20.1 billion. But, in the following month, though RBI sold USD 10 billion worth of dollars, it purchased a higher amount at USD 11.7 billion.

Data on the RBI’s interventions is not available after April, yet. But, its interventions to stop the rupee from depreciating is evident from the fall in India’s forex reserves. These fell from USD 597.7 billion as of April 30, 2022 to USD 588.3 billion as of July 1, 2022.

More direct measures were taken on July 6 to attract capital flows and thereby stem the fall of the rupee.

Incremental FCNR(B) and NRE deposits were exempted from the maintenance of CRR and SLR, with effect from July 30. This relaxation will be available for deposits mobilised up to November 4, 2022. Banks have been temporarily permitted to raise fresh FCNR(B) and NRE deposits without any ceilings on interest rates, as was the case so far, with effect from July 7, 2022 up to October 31, 2022. Reportedly, banks could save 30-35 bps on their fresh on FCNR and NRE deposits. Thus, banks are expected to to increase deposit rates on new FCNR and NRE deposits.

Immediately after the announcement of these measures, a host of banks including State Bank of India (SBI), ICICI Bank and IDFC First Bank raised interest rates on FCNR(B) deposits. SBI raised rates by 80-90 bps for various tenures. HDFC Bank also raised FCNR rates but this was not in response to the RBI measures. So, there is still scope for a further hike in its FCNR interest rates.

RBI has removed the restriction that not more than 30 per cent of investments, each, in government securities and corporate bonds by foreign portfolio investments could have a residual maturity of less than one year. This exemption is till October 31, 2022. But, this exemption may not help.

As of 15 July, only around 28.8 per cent of FPI limit in gsec had been reached for eligible general foreign investors whereas for long term foreign investors this was 11.6 per cent. FPI in corporate bonds was 17.7 per cent of the limit by mid-July 2022.

The limit for borrowers to raise external commercial borrowings (ECBs) under the automatic route was doubled from USD 0.75 billion to USD 1.5 billion per fiscal year. The all-in cost ceiling under the ECB framework was also raised by 100 bps for borrowers with investment grade rating. The facility would be available till December 31, 2022.

The very short window for which this facility is available, the sharp depreciation of the Indian rupee and the rising interest rates in the US and other economies makes raising funds through ECBs less attractive.

On July 11, the RBI notified an additional arrangement for invoicing, payment, and settlement of exports and imports in INR. For this, the exchange rate between the currencies of the two trading partner countries will be market-determined. The arrangement is expected to reduce the demand for foreign exchange for trade purposes.

In spite of the various measures taken by the RBI, the Indian rupee has continue to slide. Between July 7 and July 15, the rupee slid 1.1 per cent.