RBI takes measures to increase dollar inflow

8 Jul 2022 , 08:37 AM

Is it déjà vu from 2008 or 2013? After the Reserve Bank of India (RBI) announced its thoughts on Wednesday, that is what has started to circulate in the minds of individuals who have observed those years in the financial markets.

Some consider the RBI’s most recent set of actions as evidence of its foresight when the central bank is forthright about its plans to accept more foreign exchange and Taper Tantrum 2.0 may be occurring in markets as widely apart as Jakarta and Johannesburg. Others, though, contend that the tactics indicate impending unrest.

While the Dollar Index DXY has increased by 11.4% this year, the Indian Rupee has decreased by roughly 6%. The sell-off by foreign investors has so far been tolerated by the stock market. Bond yields increased sharply to 7.60%, however, this gain is modest in comparison to inflation. Above all, as of June 24, there were $593.3 billion in foreign exchange reserves. When Ben Bernanke discussed ending the Quantitative Easing in 2013, it was less than half of this figure.

Why did the RBI raise the ceiling on interest rates on deposits from Indians living abroad given this configuration? Why are the external commercial borrowing programme for corporations’ limits being doubled? If there is already space, what would a wider pool of bonds and securities for foreign investment accomplish?

According to general agreement, the RBI might feel uneasy if the rupee crosses the 80-to-the-dollar threshold. It does not want to spend all of its reserves defending a level of currency. And take proactive measures to stave off a potential crisis.

Although the decision to increase the foreign exchange cushion is well-intentioned, financial markets may start to shift in the opposite way during periods of increased volatility. For central bank actions to have the desired effect on markets, they must be successful. The results might be worse than they otherwise would have been if they don’t.

Will banks increase interest rates on deposits made by Indians living abroad in an effort to attract US dollars? Will banks expose themselves to unfavorable currency moves when the financial markets are volatile? In every prior crisis, that was the disputed subject.

The 7-year and 14-year government bonds that would be accessible to international investors via the automated method have been introduced by the RBI. It is unlikely that much would flow through this route when the asset swap arbitrage is limited. According to CCIL data, foreign investors possess bonds in this market worth Rs51,640 crores.

Furthermore, the cap on external commercial borrowing for businesses has been quadrupled to $1.5 billion, which may not be an incentive given the expenses of hedging, while Indian interest rates are kept relatively low for a steady economic recovery.

The RBI’s warning shot may have been more justified as a result of red flashes in the real economy than in the financial markets. The monthly trade deficit is at a record level. Given unbudgeted growing subsidies, the fiscal deficit aim could be put to the test. These twin deficits have historically been crucial in devaluing the currency.

Since RBI wants a long-lasting economic recovery, it is hesitant to hike interest rates significantly in order to reach its target. Higher interest rates must be used to draw foreign capital if the currency is to remain stable.