Why a torrent of foreign funds threatens India's tight grip on the rupee

 

There's growing consensus among traders and fund managers that the mounting pressures -- particularly the liquidity glut distorting money markets -- may spur the central bank to consider changes.

A relentless torrent of funds rushing into India’s markets may tip the central bank’s delicate balancing act in 2021.
For most of this year, the Reserve Bank of India has capped currency gains as global investors poured around $50 billion into stocks and stakes in companies. This has boosted rupee liquidity in a banking system that’s already flush with cash from the RBI’s stimulus measures.

There’s growing consensus among traders and fund managers that the mounting pressures -- particularly the liquidity glut distorting money markets -- may spur the central bank to consider a range of changes, from relaxing its grip on Asia’s worst-performing currency to curtailing bond purchases.

A modest gain in the rupee over the past month could mean that policy makers are already dialing intervention down a touch, or that inflows are starting to get the better of them.

“We believe that the RBI is facing a tough task of liquidity management while juggling FX inflows, secondary bond market purchases to keep long-term borrowing costs low and ensuring money-market rates are aligned to the policy rate,” said Kanika Pasricha, an economist at Standard Chartered Plc in Mumbai. Steps must be taken to realign money-market rates with policy rates, she said.

Reserves surge as RBI snaps up dollars

While most currencies in Asia have benefited from a weaker dollar, the rupee is down 3% this year. Traders point to how the RBI has bought $58 billion of dollars in the first nine months of the year as signs of its intervention.

Governor Shaktikanta Das has only commented very broadly on the matter, writing in the most recent policy statement that the central bank acts to damp forex volatility and keep the rupee in sync with underlying domestic fundamentals.