Once a big dollar buyer, the Reserve Bank of India (RBI) has made it clear on which side of the market it would be amid the rising pain from the novel coronavirus pandemic.
The central bank on Thursday said it will conduct simple sell/buy dollar swaps worth $2 billion through an auction method. In a sell/buy swap, banks would buy dollars from RBI and simultaneously agree to sell them back at the end of six months.
The need for the measures was obvious. “The impact of the Covid-19 outbreak in India has started to weigh on the rupee, and if it continues, equity portfolio flows could accelerate, acting as a drag on the currency," pointed out analysts at UBS Securities India Pvt. Ltd.
Dollar outflows have increased from emerging markets including India as the coronavirus pandemic shuts down parts of trade and supply chains across the globe.
Thursday’s measures reduce the immediate pressure on the spot rupee by postponing the outflow of greenbacks. The central bank would be providing dollar liquidity.
That said, the markets don’t appear too enthused. The rupee ended 0.7% weaker 74.22 on Thursday, just a shade away from its all-time low. According to analysts, the measures may slow the process of rupee depreciation, but may not change the direction of the Indian currency.
Perhaps the central bank is aiming only to slow the process. As the adjoining chart shows, RBI has been a massive dollar buyer even when the rupee was weakening. It bought $40 billion in 2019, its biggest haul in a decade. In January this year, the central bank bought $10 billion from the market.
Economists at BofA Securities Ltd believe that RBI is unlikely to keep up with dollar selling. “Governor (Shaktikanta) Das will likely continue to buy forex, even at the cost of a weaker INR, to guard against contagion.We ourselves place ‘conservative’ FX reserves at US$550 billion," it said in a note. The sharp fall in oil prices and the meltdown in global equity markets in the wake of the coronavirus outbreak have triggered fears of a contagion.
India’s foreign exchange reserves stood at $481.5 billion at the end of February. But a mere forex reserve pile-up is not the intention behind the dollar purchases of RBI. The rationale for this buying is that a slowing economy has little absorptive power to swallow large dollar inflows.
The risk of a global recession would mean India’s growth too would be affected. The country’s economy is already at its slowest pace of growth in six years and the hit from the coronavirus pandemic may increase the pain further.