For an author, the best reward is when his or her reader writes either praising the author or coming up with constructive feedback. This is what I exactly received from a reader, Ms Swetha Pabbu. The article on capital expenditure and costs raised a query and that was why the rupee is appreciating against the dollar — deviating from its usual behaviour. For ages, the rupee has depreciated against the universal currency. Other than global factors, the role of the Reserve Bank of India (RBI) and the government come into play.
RBI’s role in the forex market
Normally, RBI buys dollars from the market which results in a rise in rupee liquidity. The increase in the supply of rupee without a corresponding demand makes the rupee depreciate against the dollar. Thus, buying and selling of dollars are one of the ways to increase or contract the supply of rupee in the market.
RBI uses this tool of buying and selling to keep Indian exports competitive in the international markets, to build strong forex reserves and to negate actions of foreign Central Banks.
Since March 2020, RBI has accumulated more than USD 62 billion and total reserves stand at more than USD 530 billion — the fifth largest reserve in the world. This was mainly done because RBI was on a streak to increase the liquidity in the economy and ease the pressure built up by the COVID-19 pandemic.
However, the million-dollar question asked by businesses is whether RBI is loosening its reins on the rupee?
The record inflow of dollars through Foreign Portfolio Inflows (FPI) and other modes have increased the demand for the rupee. This has led to rupee appreciating against the dollar.
While these factors are playing up, RBI is also concerned about the increased headline inflation. We also know increased liquidity also increases inflation. Thus, our view is that RBI may not further buy dollars from the markets until the time uncertainty looms around its inflation target. Besides, RBI won’t do much to arrest this appreciation as this will help in reducing the import cost and also keeping in check cost-driven inflation and inflation related to recent supply chain disruptions.
In the short term, we believe that the rupee will appreciate against the dollar or to say the least be guided by the market forces as the RBI won’t intervene much to keep inflation within its range. Thus, our analysis shows that in the short term the rupee will appreciate against the dollar for some time. However, in the long term, RBI will ensure a depreciation of rupee to help exporters. But no one will be able to predict the time and future trends.
Strategy for businesses exposed to foreign exchange (Forex)
Given the situation we have advised all our clients as below:
- Exporters are advised to sell their exposure in tranches or whenever the rupee depreciates above the 74.5 mark. Also, it is advisable to hedge more than 70 per cent of forex exposures.
- For businesses with import bills, they can hedge their exposure by buying a call option to keep the downslide open.
This is our considered view keeping in mind all available information. However, request all business persons to take their own decision after considering all pertinent factors.
Predicting currency movement is very tricky given the black swan events. Hence, we believe that it is best for a business person to hedge and insure the business against the volatility of currency movements.
(inputs by CA Abhay Nair)
Dr Menon is a business coach and has a youtube channel menonmantras where many videos are uploaded for the benefit of the business community and employees.