The rupee has strengthened against the USD by around 1% during the period March 31, 2017 to April 27, 2017 on account of continued foreign inflows into the Indian markets. The Euro has appreciated against US dollar by around 2% during the same time period.
The question being asked is whether the rupee will continue to rein strong in the coming days or will there be an intervention from the RBI. The issue hence is two-fold. First there is the factor of inflows which have buoyed the rupee. The second is that the dollar has also weakened during this period against the euro which should translate into a strengthening of other currencies. How is one to view these movements for the future?
Chart 1 shows the movement in both the rupee vis-à-vis the USD and the latter relative to the euro. The rupee had moved past the 65 mark in the beginning of the month but then corrected to strengthen and is close to Rs 64 as of today. The USD began at a stable pace but has moved from 1.07 to 1.09/euro.
Chart 2 tracks the movement in FPI which have been responsible for this movement. As can be seen, the inflows into debt have increased while those into equity have started off positive before tapering into the negative zone and recovered marginally towards the end of the period. Quite clearly, the sentiment factor has also played a role in the strengthening of the rupee besides the USD-euro movement.
There has been a differential pattern in movement of currencies during this period:
Mexican peso depreciated the most (by 1.6%) out of the 15 currencies, followed by South Korea won (1.32%),
Russian ruble(1.20%) and Brazilian real(1.01%) during 31 Mar’17- 26 Apr’17.( Refer Chart 3)
Currencies such as Indian Rupee, Malaysian Ringgit, Philippines Pesos, South African Rand and Turkish New
Lira have strengthened against US dollar during the same period.
Implications of a stronger Rupee
A stronger rupee would have a negative bearing on the export oriented sectors such as IT services, Pharma, textiles, automobiles and ancillaries. It could impair the improvements in exports being seen in the recent months.
Stronger rupee will result in lower crude oil prices for the Indian economy. This in turn is expected to reduce the
Wholesale price inflation and will benefit aviation sector (importer of crude oil) besides other related products.
Companies having foreign denominated debt will benefit from a stronger rupee.
Remittances will be negatively impacted as they will deliver lower value when converted to rupees.
What will RBI do?
In order to keep the rupee stable, the RBI may intervene in the foreign exchange market by buying dollars.
The decision will be based on the judgment on what has caused the rupee to move up so fast. If it were just the fundamentals, then the probability of intervention will be minimal. However, if it is driven by speculative forces which have made the market volatile, there would be proactive measures invoked by the central bank.
This however will result in injecting liquidity at a time when the markets are already facing the situation of excess liquidity. Therefore, RBI may have to use compensating tools such as Open markets operations, MSS bonds, cash management bills and variable reverse repo rate to absorb the excess liquidity. This will have to be done to stabilize bond yields.