When Apr-21 began, the Indian rupee was quoting at Rs72.5/$. After the monetary policy was announced on 07 April, the rupee fell sharply from 72.5/$ to beyond 75.3/$. Of course, the 4% correction did not last long and the rupee bounced back to Rs74.05/$ by end of April. The month has kept the rupee under pressure; more so as the rupee was steady between 72.1/$ and 72.5/$ through most of 2021.
Dollar Story - How the Rupee weakened versus the US Dollar in Apr-21
Chart Source: Trading View, Asia
There were several reasons for this sharp rupee fall in April 2021. The obvious reason was the resurgence of COVID in large swathes of India, putting the nascent growth recovery in danger. That was compounded by the US economy growing at an average of 5.5% in the last two quarters, which could potentially strengthen the dollar. There is also the issue of portfolio flows. FPIs pulled out Rs12,039cr from Indian equities in April, but this trend of FPI weakness was evident since late February.
The immediate trigger for the weakening of the rupee was the monetary policy announced on 07 April. Among other things, the policy announced huge cash infusion via the purchase of G-Secs via G-SAPs. These G-SAPS were supposed to enhance rupee liquidity in the Indian financial markets. It raised dollar demand and was the immediate trigger for the weakening of the rupee. However, as we will see, there was more to the rupee weakening.
1. Government will print more money with G-SAPs
In the April monetary policy, the RBI announced the launch of the Government Securities Acquisition Program (G-SAP). As the first step, the RBI will infuse Rs100,000 crore by June. Where does the money to buy government securities come from? That comes from printing notes. Generally, asset purchase programs are described using terms like quantitative easing, monetary stimulus, G-SAP, balance sheet expansion, etc. In layman’s language; it means the RBI is printing more notes. What does that imply?
Once there is a surfeit of rupee liquidity due to G-SAP, there is reduced demand for rupees and greater demand for dollars. This weakens the rupee against the dollar. That is what happened after the monetary policy announcement. RBI infused Rs79,700cr in the Mar-21 quarter and another Rs25,000cr on 15 April. By end of Jun-21, it would have printed and infused Rs200,000cr of fresh money.
2. Fiscal deficit and the borrower’s dilemma
India has pegged its fiscal deficit at 9.5% in FY21 and 6.8% in FY22. Accordingly, the borrowing target stood at Rs12-13 trillion for FY21 and also for FY22. The government needs to stimulate the economy in the midst of the pandemic. But, the government has a dilemma. Since the borrowing target is huge, it must borrow at low yields but banks are not interested in government securities at low yields. Effectively, the government ends up buying its own bonds via the RBI.
This dilemma is handled through yield management. RBI governor has stated in the post-policy interview that RBI would do its best to help government borrow at low yields. RBI will have to ensure that there are enough rupees sloshing around in the system by constantly printing money to keep yields low. But this has repercussions too. US bond yields have gone up from 0.51% in Jul-20 to 1.76% in Apr-21. That means; money leaves India and finds safe and profitable havens in US treasuries. That also strengthens the USD and weakens the INR.
3. RBI is avoiding intervening in the dollar markets
Logically, the RBI can just intervene in the forex market and sell dollars to provide support to the rupee. The RBI is not doing that for two obvious reasons. Firstly, the RBI wants to ensure that there is a glut of rupees in the system so that the Indian government can continue borrowing at low yields. RBI is avoiding intervention by selling dollars as it would suck rupees out of the system and make its job difficult.
Secondly, the government benefits from a weak rupee as it boosts exports and keeps the trade deficit in check. On the imports side, the pandemic-driven slowdown is keeping crude oil prices in check and addressing India’s biggest macro pain point. By not intervening and letting the rupee weaken, the RBI is actually hitting two birds with one stone.
4. Good old carry trades are unwinding
Carry trade is a popular international arbitrage strategy employed by traders in financial markets. They borrow in a currency where interest rates are very low (like the Japanese Yen) and invest in rupee assets where yields are much higher. An unwinding of carrying trades happens in an anticipatory fashion. When traders see the rupee weakening, they unwind carry trades and further weaken the rupee. That was visible in the month of Apr-21.
The rupee has been weak because that is, perhaps, the need of the hour. It may remain so as long as the government has an aggressive borrowing program.