Does RBI have options if rupee falls dramatically to 80 and beyond against US dollar?

The Reserve Bank of India (RBI) has a wide range of policy options to combat any sharp depreciation in the rupee value against the US dollar. The rupee is currently trading at 77.55 against the US dollar

This includes allowing banks and financial institutions to raise dollar deposits, raising the domestic debt limit for foreign investors, discouraging certain imports with higher duties, encouraging exporters to bring back dollar proceeds, etc. In the taper tantrum of 2013, when the US Federal Reserve indicated withdrawing the surplus liquidity, the RBI, facing a sharp depreciation in rupee value, had decided to allow foreign currency deposits with concessions on the hedging costs. In fact, banks mobilised close to $35 billion via this attractive route, which helped in checking the rupee depreciation. 

"RBI may be comfortable in not taking any action to put pressure on exporters. But, if required, it may ask exporters to bring back dollars faster. On outflow, putting a restriction would be derogatory in view of the fact that, as an economy, we are still very closed on the capital account. So, I don't expect any restrictions on outflow unless the RBI is pushed to the wall," said Anil Kumar Bhansali, Head of Treasury, Finrex Treasury Advisors.

"One big bang idea on the capital flows side could be the inclusion of Indian debt in global bond indices. This will increase the participation of Indian paper in global non-discretionary investment flows. The announcement of intention itself can result in a significant appreciation of the rupee," pointed out Abhijeet Awasthi, a currency trader.

The recent uncertainty following rising interest rates in the domestic as well as global markets, a hawkish central bank outlook because of inflationary trends and higher oil prices have kept the pressure on rupee value against the US dollar. In fact, the US inflation data yesterday was higher than expected, which makes a strong case for further hikes of 50 basis points in the US Fed rate from the current 0.75-1.0 per cent.

"The central bank, in order to curb major depreciation of the currency, has used some of its reserves, and the RBI seems to be not very comfortable keeping its reserves below the $600 billion mark," observed Gaurang Somaiya, Forex & Bullion analyst, Motilal Oswal Financial Services.

"We expect that the RBI will continue to actively intervene and, at some point, will again start to build up its FX reserves to create a buffer for future uncertainties" Somaiya added.

A combination of RBI's intervention in the forex market by selling dollars and depreciation in the value of forex reserves have already resulted in the country's forex reserves falling from $640 billion to $600 billion. Is there a tolerance limit for forex reserves (say, $550 billion) below which the RBI will stay out of the forex market?

The adequate level of foreign exchange reserves is actually measured in relation to import cover as well as short-term foreign currency debt. 

"India's imports are close to $55 billion per month. As per a conservative estimate, the country needs to have a reserve equivalent of 10–11 months. By this parameter, the current reserves of $600 billion are adequate," pointed out Awasthi. 

The second method is to look at the country's total short term debt obligations due in the next one year, which currently stands at around $100 billion.

"RBI has long forex dollars to the tune of $49 billion, apart from the reserves of $600 billion, which can also be used by them to protect the sharp depreciation. So, in fact, they have $650 billion to protect the value of the rupee, of which they can use $50 billion more to intervene. The strategy would be to allow a slow depreciation with some appreciation so that importers can also be protected to some extent. Overall, the trend would be of depreciation till we see a reversal in the dollar index, " said Anil Kumar Bhansali, Head of Treasury, Finrex Treasury Advisors.

"RBI would consider the worst-case scenario where the FDI outflows are happening, the trade deficit has to be financed, and short-term debt has to be serviced. This will put immense pressure on the rupee. In that scenario, it is logical that the RBI will allow an orderly depreciation using the reserves judiciously," said Awasthi.

Also read: Rupee opens at 77.52/$ vs Wednesday’s close of 77.24/$