RBI Policy May Touch On Currency Intervention

Indian Rupee (INR) depreciated this week historically against the US Dollar index, as investors were flocking to the US dollar as a safe haven concern. However, today, INR increased 37p to 81.30 against the US Dollar, while the US currency cools down to around 112.80. As of September 27, 2022, the INR weakened 9.1% against the US Dollar in CY22. Meanwhile (Chinese Yuan) CNY/ (Indonesian Rupiah) IDR/ (Malaysian Ringgit) MYR depreciated by 11.1%/ 6%/ 10.6%, respectively against the US Dollar. Emerging Market Currencies like the Philippine peso (PHP) and Thai Baht (THB) are struggling even more. Hence, in tomorrow's RBI policy meeting, intervention in the currency market by the Indian central bank will be a major concern to ease the Rupee fall.

Analysts at Motilal Oswal Think

There is no direct connection between the extent of rate hikes (or monetary tightening) and currency depreciation.

However, before fighting the currency depreciation, the RBI must look into the causes of currency movements and compare the movements in the INR against the USD with other emerging market (EM) counterparts. If all major EM currencies move in tandem, but the INR weakens disproportionately more than others (like in CY13-14), then it is a cause of concern and may justify RBI's intervention. However, if the weakness in the USD:INR is in line with or less than other EM currencies, it is best for the RBI to let INR be as market-determined as possible. This is because of three reasons.

The currency market is truly global in nature and the RBI has limited powers to manipulate it. There is no evidence of the RBI (or any other Central Bank) being able to successfully mitigate depreciation pressures for long.

Any measure to mitigate currency depreciation by the RBI will inevitably involve a tighter monetary policy. It is, thus, very important to conduct a cost-benefit analysis of RBI's currency market interventions.

Intervention by the RBI (or any other EM central bank) in the currency market to mitigate depreciation comes at the cost of extremely valuable foreign exchange reserves (FXR). However, it comes with a natural constraint.