Rate hike sign RBI more concerned about rupee

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IANS | 05 Aug, 2022
With the Reserve Bank of India (RBI) on Friday raising the repo rate by 50 basis points to take it to pre-pandemic levels at 5.40 per cent, as the MPC seeks to bring inflation closer to the mid-point of 4 per cent, the SBI Ecowrap report said it indicates the central bank is concerned about the global situation.

RBI retained CPI inflation projection for FY23 at 6.7 per cent, and the RBI Governor mentioned that this does not take into account the impact of monetary policy actions taken now.

Even though the RBI may have frontloaded the rate hikes, it remains to be seen how it influences the trajectory of rupee over the medium term. While the rupee did witness a smart recovery after the policy announcement, it was unable to hold onto the gains. Research suggests that countries with low prior FX reserves are more likely to choose an interest rate defence than countries with high reserves. This is probability, not the case for India (FX reserves: $572 billion).

"Further, defending the currency through interest rates could also indicate the market participants getting into a self-fulfilling prophecy of expecting more rate hikes to automatically protect the domestic currency whenever it is under pressure. However, in a situation when current account deficit is likely to cross 3.5 per cent, raising the rates might be the best carry trade bet to finance the large CAD," the SBI Ecowrap report said.

This rate hike indicates three possibilities: that the last 50 bps hike did not have any material impact on the inflation trajectory as of now and will impact inflation in the longer horizon, that the RBI does not want to put a lower inflation forecast at this time as it wants to remain ahead of the curve in an uncertain global environment of currencies and inflation, and Friday's 50 bps hike is an indication that the RBI is more concerned about rupee and external situation, i.e. using interest rate as an defence to protect the rupee.

In the policy statement, RBI Governor Shaktikanta Das said that the Indian rupee has moved in a relatively orderly fashion depreciating by 4.7 per cent against the US dollar during the same period - faring much better than several reserve currencies as well as many of its EME and Asian peers. The depreciation of the Indian rupee is more on account of the appreciation of US dollar rather than weakness in macroeconomic fundamentals of the Indian economy.

During the current financial year (up to August 4), the US dollar index (DXY) has appreciated by 8 per cent against a basket of major currencies.

"Market interventions by the RBI have helped in containing volatility and ensuring orderly movement of the rupee. We remain watchful and focused on maintaining stability of the Indian rupee," Das added.

The RBI retained real GDP growth projection for FY23 at 7.23 per cent and CPI inflation projection at 6.7 per cent for the similar period.

"In India, the RBI has reiterated its commitment to bring inflation down hinting at future rate hikes without giving the exact amount of rate hikes. However, the word count analysis of the Governor's statement indicates how rupee is getting featured more often along with inflation and growth," the report said.

On the liquidity situation, the report said that the system liquidity has been in the surplus mode this fiscal. As liquidity in the banks squeezed, banks had to resort to MSF borrowing between July 22 and July 28.