Rajan Plays Long Game by Building Reserves Chest as Rupee Slumps

  • Currency stockpile has increased $4.3 billion in three weeks
  • Some rupee weakness is needed until inflation is curbed: Rajan

Reserve Bank of India Governor Raghuram Rajan is rebuilding the country’s foreign reserves as he sees an unavoidable slide in the rupee until the war on inflation is won.

The currency stockpile grew by $2.3 billion in the week to Feb. 5, the most since the period ended Sept. 11, according to central bank data compiled by Bloomberg. The reserves have risen $4.3 billion in three straight weeks, the longest run since October, as the rupee fluctuated before declining to within 0.3 percent of its record low on Wednesday.

Rajan said on Feb. 13 a certain amount of depreciation “is necessary” until inflation comes down, noting India’s need to keep its competitive edge in global trade. While the rupee has declined 3.8 percent versus the dollar in the past three months amid outflows from bonds and stocks, it was about 24 percent overvalued against the RBI’s basket of six currencies at the end of January on a trade-weighted and inflation-adjusted basis.

"There was a bit of a pause, but they are back to the policy of reserves accumulation, building up the war chest, and really being able to continue to be able to dampen the volatility in the currency market,” said Mitul Kotecha, head of Asian foreign-exchange and interest-rate strategy at Barclays Plc in Singapore. “Rajan’s comments indicate the RBI is likely to steer the currency on a fairly steady depreciation path along the lines of keeping a fairly stable real-effective exchange rate.”

The rupee is Asia’s worst performer after South Korea’s won in the past three months as overseas funds pulled a net $3 billion from Indian stocks, and foreign holdings of local debt fell by $1.5 billion amid a global wave of risk aversion and slowing growth at home. The Indian currency fell 0.4 percent to 68.6350 a dollar as of 9:48 a.m. in Mumbai. It sank to an unprecedented 68.8450 in August 2013.

“Our intent is not to depreciate the rupee in a steady way or anything of that sort,” Rajan said in a speech in the southern state of Kerala. “Our focus is on bringing down inflation so that people will not have to ask why the rupee is weakening.”

Rajan is accepting a weaker rupee as exports contracted for the 14th straight month in January. The fastest consumer-price gains in 17 months has kept him from adding to last year’s four interest-rate cuts. Asia’s third-largest economy expanded at the slowest pace in three quarters in the three months ended December.

“Governor Rajan was quite clear in saying that to maintain competitiveness you either reduce inflation or weaken your currency,” said Nizam Idris, head of foreign-exchange and fixed-income strategy at Macquarie Bank Ltd. in Singapore.

Currency Forecasts

Macquarie predicts the rupee will fall to 70 a dollar by end-June, the most bearish forecast in a Bloomberg survey of 34 analysts, while Barclays sees a decline to 69 and ING Groep NV to 68.50. The median estimate is for the currency to strengthen to 68 in the period.

Rajan can afford some depreciation without having an impact on living costs due to a decline in commodities. While consumer price increases quickened to 5.69 percent last month, it has halved from its November 2013 peak of 11.5 percent as a slump in crude prices benefits the nation that imports about 80 percent of its oil. The RBI is targeting a 5 percent inflation rate by the end of March 2017 and 4 percent the following year.

“Given that commodity import prices are at cyclical lows and not expected to rebound anytime soon, he’s seen this as an opportunity to take the foot of the pedal on the currency front,” said Viraj Patel, a London-based strategist at ING, among the most accurate forecasters of the rupee in Bloomberg’s rankings. “This confirms an RBI more tolerant of any near-term rupee downside.”

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