Rupee’s slide pits RBI against market full of bears

By Subhadip Sircar and Vrishti Beniwal

The rupee’s tumble to a succession of record lows is sparking fears of a deeper selloff and pitting the central bank against analysts and strategists who are predicting further losses.

The currency has already dropped more than 6 per cent this year, putting it on the threshold of 80 per dollar for the first time, as fears of a global recession and spiraling oil prices fuel outflows and deficits. The authorities are well aware of the potential risks, with the Reserve Bank of India and the government announcing a raft of measures in the past week to support the currency.

The current slump has brought back memories of the rupee’s frantic selloff in 2013, a time that also saw widening current-account and fiscal deficits, accelerating inflation and rising US Treasury yields. Back then, the currency fell steadily for several months before the war in Syria caused oil to spike and the rupee to tumble as much as 3.9 per cent on a single day, the biggest loss in two decades.

“The better macro backdrop compared to 2013 probably increases the possibility of modest success from these soft capital-account liberalization measures and buy some time for the RBI,” Citibank Inc. economists including Samiran Chakraborty in Mumbai wrote in a research note. “However, the macros need to improve for the RBI to move out of this policy conundrum.”

Also Read: Inflation expected to cool from October, says RBI’s Shaktikanta Das

Analysts and market metrics are both overwhelmingly bearish, even after the latest steps. Options on the rupee are pricing in a 52 per cent chance it will weaken to 82 per dollar by year-end, which would increase this year’s decline to almost 10 per cent, making it the worst year since 2013.

Among the rupee-supporting measures announced Wednesday, the Reserve Bank of India said it was raising overseas borrowing limits by companies and relaxing foreign ownership rules in government bonds to bolster foreign-exchange reserves. The central bank also said it stepped in to alleviate dollar tightness with the objective of ensuring orderly market functioning.

‘Delicate Balance’

The RBI’s currency intervention is already making inroads into its cash pile, with foreign reserves dropping to $593 billion in June, from as high as $642 billion in September last year. While that’s still well above the low of $275 billion in 2013, it has now dropped in six of the past eight months.

“India’s stockpile of foreign-exchange reserves could erode rapidly in the event of a capital outflow-currency depreciation spiral,” said Eswar Prasad, a professor at Cornell University and senior fellow at the Brookings Institution in Ithaca, New York. “The RBI has to maintain a delicate balance between supporting growth on the one hand, and limiting domestic inflation and currency depreciation on the other.”

Also Read: Commodities slump is set to give India relief from inflation

Nomura Holdings Inc. forecasts the currency will depreciate to 82 per dollar by September, while Goldman Sachs Group Inc. and Bank of America Corp. both predict it will weaken to 81 by year-end. The currency gained 0.2 per cent Thursday to close at 79.1775 after sliding to a new all-time low of 79.37 on Wednesday.

Among negative market metrics, the number of open positions in dollar-rupee call options easily exceeds those in puts with expiries ranging between now and year-end. That means there are more positions that will benefit from a rupee decline than those that will benefit from a rally.

So-called “volatility skew” analysis, which compares implied volatilities on two different dates across a range of strikes shows investors are continuing to buy dollar-rupee call options at much higher premiums relative to puts. That indicates traders are anticipating continued pressure on the rupee.

No ‘Line in Sand’

New Delhi is viewing the evolving situation with concern but doesn’t immediately see it as a crisis as there are similar conditions across emerging markets, a senior finance ministry official told Bloomberg last week. The government doesn’t have any specific line in the sand for the rupee in mind, said the person, who asked not to identified.

The central bank is also sticking to its policy that it doesn’t target a specific level, but is only intervening to smooth out volatility.

There’s at least one gauge that shows the rupee remains expensive even after its recent declines -- mainly because its losses this year have been less than many of its other peers.

Also Read: Macro data, Q1 earnings, global cues to dictate market trend this week

The rupee’s real-effective exchange rate against a basket of currencies of 40 of India’s trading partners was at 104.90 at the end of May, above the threshold of 100 that is considered to be fairly valued, according to an RBI index.

‘Risks Building’

With the market predicting further losses, the authorities may not have a lot of room to maneuver.

“It is clear that India’s comfort level regarding its FX reserves buffer to withstand global spillover risks will be reducing over the coming months and quarters,” Kaushik Das, chief India economist at Deutsche Bank AG, wrote in a research note this week. “We are not surprised that the government and the RBI have started announcing more targeted measures to improve the balance of payments outlook and defend the rupee.”