India has a currency problem and it’s not going away anytime soon.
A current-account deficit at a five-year high, elevated oil prices
and an emerging-market sell-off have conspired to push the rupee to below 72 per dollar
last week, taking its decline since the beginning of the year to almost 12 percent, the worst performer in Asia.
Pressure is mounting on the Reserve Bank of India to take stronger action to stem the currency’s slide. The central bank has already raised interest rates twice since June and depleted billions of dollars to bolster the currency, but with little success.
Here are some conventional and some not-so usual measures policy makers may consider:
The RBI raised its benchmark rate to a two-year high of 6.5 percent last month and is likely to follow through with more policy tightening in the coming months, pricing in the swap markets show.
The central bank targets inflation, not the exchange rate, and attributes any interest-rate moves to its goal of containing rising prices. While data on Wednesday will probably show inflation eased to 3.8 percent in August, according to a Bloomberg survey of economists, the outlook remains uncertain given the rupee and higher oil prices.
“The joker in the pack is the currency,” said JPMorgan Chase and Co.’s chief India economist Sajjid Chinoy, adding the rupee’s rapid fall might force the RBI’s hand sooner than later.
The six-member monetary policy committee will make its next rate decision on Oct. 5.
India isn’t alone in Asia in raising rates to curb inflation and stem foreign outflows. Indonesia has increased rates four times since May while the Philippines has tightened as well.
The RBI intervenes regularly in the foreign-exchange market to smooth volatility.
Citigroup Inc. economists Samiran Chakraborty and Anurag Jha estimate the RBI sold about $2 billion in the spot market in August, well below the $4.7 billion average in the April-June period. It also sold about $10 billion in the forward market in the three-month period, according to data from the central bank.
The intervention has taken a toll on foreign exchange reserves. From a record $426 billion in mid-April, reserves have fallen to $400 billion in August -- enough to cover eight months of imports.
One of measures being actively considered is turning to wealthy non-resident Indians to replenish foreign-currency reserves. This option was exercised in 2013 when a discounted swap window lured inflows of about $34 billion. Authorities also tapped overseas Indians in 1998 and 2000 to ward off pressure on the rupee.
Indranil Sen Gupta, India economist at Bank of America Merrill Lynch, says if capital flows don’t revive, the government may once again turn to non-resident Indians to raise $30 billion to $35 billion. India can also consider raising $5 billion through a sovereign bond issue.
A government official told reporters on Monday that the government was considering a plan to tap its citizens abroad.
The trade war
is the new weapon in town. India, with its past experience of relying on higher duties to curtail imports, could use it to curb the current-account deficit, as Indonesia recently did.
In the aftermath of taper-tantrums in 2013, India hiked import duties on gold bullion and jewelry. That saw inflows shrink, helping narrow the current-account gap. This time around, electronics imports have outstripped gold.
The RBI can open a special swap window for oil marketing companies like it did in 2013. That would take a sizable amount of dollar
demand off-market and boost the rupee.
“A re-introduction of this policy for oil marketing companies and potentially for defense-related imports could provide some support for the rupee in the near term," Barclays Plc analysts Siddhartha Sanyal and Rahul Bajoria wrote in a note.
Back in 2011, domestic exporters and importers were prevented from re-booking forwards contracts, and this could again provide support for both spot and futures, Barclays said.
Verbal intervention is always an option. While the RBI has said it doesn’t target any level for the exchange rate, government officials say they have sufficient firepower to deal with the rupee’s decline.
The right level for the rupee is 68-70 per dollar, with 72 being “perhaps an outer limit or beyond the reasonable outer limit for depreciation,” Economic Affairs Secretary Subhash Chandra Garg told the Economic Times in an interview this week. “Those operators who are trying to take advantage of this contagion feeling in emerging markets
may come to grief later,” he said.
Some officials like Rajiv Kumar, vice chairman of the government think-tank NITI Aayog, have maintained that the rupee is overvalued on a real effective exchange rate level. A 36-country trade-weighted index of the exchange rate dropped to 115.15 in July from 120.02 a year ago, central bank data shows. A level higher than 100 suggests an over-valuation of the exchange rate, while a level below that suggests undervaluation.