Record reserves empower Rajan

India’s volatile currency weakened by uncertainty

INDIA’S foreign exchange reserves have surged to a record this month. The timing could not have been better. As anxiety around a potential British exit from the EU reaches fever pitch, rupee swings are rising at the fastest pace since August last year.

Add to that an estimated $20-billion (about R300-billion) outflow from maturing foreign-currency deposits come September and the possibility of Reserve Bank of India governor Raghuram Rajan being replaced, and the central bank may need to draw on its war chest to stem swings in Asia’s worstperforming currency.

“A lot of global and domestic headwinds are coming together and that could make the rupee market very volatile,” said Amit Agrawal, a currency strategist at Societe Generale in Bengaluru.

“Record reserves and the central bank’s proactive approach will help contain the volatility. All eyes are on September.”

Uncertainty about the UK’s referendum on Thursday has cast a pall over the global outlook, spurring risk aversion across emerging markets.

Some investors have also flagged concern about the dollar-deposit outflow affecting rupee volatility and liquidity in the banking sector, and speculation is rife about whether Rajan will serve a second term.

The rupee declined 0.6% this week to 67.165 (about R15.20) to the dollar in Mumbai on Friday. A gauge of its one-month implied volatility has climbed by 90 basis points, the most since August last year, to 6.77%, as investors also dealt with central bank meetings in the US and Japan.

That is still much lower than the 22.8% level seen in August 2013, when the US Federal Reserve’s signal to end monetary stimulus triggered an exodus of funds from emerging markets such as India and dragged the rupee to a record low of 68.845 to the dollar.

The credit for this goes to Rajan. The former IMF chief economist, who took charge at the Reserve Bank in September 2013, lured inflows of about $34-billion through discounted foreign-currency swaps, helping lift the rupee from a record low. He also sought to build a war chest to help defend the rupee from global shocks, with about a fourth of India’s record foreign-exchange stockpile of $363.5-billion being added during his term. The hoard increased by $3.3-billion in the week to June 3, the most since the period ended April 1.

Investors including DBS Bank and AllianceBernstein are confident that the monetary authority has enough ammunition to mitigate the impact of the dollar outflow as most of the emergency currency swaps mature between September and November this year.

The central bank has built up net dollar purchases in the forward market worth $29-billion to cover any possible shortages, according to Morgan Stanley.

The central bank had “plenty of dollars” to tide over shortages and “in case of extreme volatility”, Rajan said this month after keeping the benchmark rate unchanged at a five-year low.

“The maturing of deposits is likely to be a molehill, not a mountain,” Radhika Rao, an economist at DBS Bank in Singapore, wrote in a note last week. “The RBI has the available policy tools to ensure that this impact doesn’t become enduring.”

The rupee is Asia’s worst performer this year, having weakened 1.5%, as foreign holdings of local-currency government and corporate debt dropped by 95.2-billion rupees.

That compares with 2016’s inflows of $2.8billion into Indian shares.

The outflows from maturing deposits “would be pretty quickly discounted if emerging markets are going through a normal, positive state”, said Anthony Chan, a senior economist at AllianceBernstein, which manages $487-billion globally.

“If emerging markets are more volatile, then this might be a reason for investors to get nervous about the rupee.”

Rajan, whose three-year term ends early in September, has taken a series of liquidity measures and infused 1.41-trillion rupees through open-market bond purchases since December last year to boost the supply of cash in the banking system. The central bank was due to buy as much as 100-billion rupees more of debt on Friday.

“If required, the RBI could resort to additional measures such as OMO [openmarket operation] purchases and additional reserve build-up in the run-up to September,” Morgan Stanley economists said this week. — Bloomberg