‘RBI letting rupee firm up to tame inflation’.

Mumbai: The RBI appears to be following a strategy of allowing the rupee to firm up in order to keep inflation under check, according to a report by Bank of America Securities. The rupee has gained 2.7% against the dollar and the central bank might be less aggressive in buying dollars as it has achieved adequacy of foreign exchange reserves, the report said. 

The RBI has historically followed a policy of graded weakening of the rupee by buying dollars when the domestic currency is firming up and allowing it to depreciate when there is a rupee sell-off, although it does use its forex reserves to prevent excess volatility. 

The risk in allowing the dollar to gain is that imports become cheaper and exports  are disincentivised. Also, it is profitable for foreign investors to sell Indian assets. A weaker rupee, on the flip side, increases domestic inflation by increasing oil prices. The rupee, which had weakened to almost 77 in the post-pandemic market crash in April, has recovered substantially and had closed at 73.46 against the dollar on Friday. 

“We think the RBI will buy forex less aggressively than in the past, having achieved adequate forex reserves (over $500 billion) again. Second, it has stated that appreciation helps cool high CPI  inflation, although we find ‘imported’ inflation relatively weak. Finally, the RBI will likely allow rupee to weaken if the dollar strengthens, as it can sell up to $50 billion to fend off any speculative attack on the rupee,” the report said.

Incidentally, the rupee has firmed up despite the RBI purchasing $24 billion of foreign currency between July and September 11, 2020. “As inflation peaks off, we think that there still will be a policy bias towards a weak rupee till growth revives. Our forex strategists see the rupee at 74 per dollar by December,” the report said. While low global rates are ensuring that funds continue to move to emerging markets, the rupee could come under pressure because of geopolitical reasons. “The mixed US data is losing the economic confidence and weighing on dollar. But in coming sessions, the Indo-China border and Brexit uncertainty will occasionally keep the dollar bulls active. This week, the spot respected both the crucial support of 73 and the resistance of 73.75. Even next week, we expect the sideways trend to continue. Unless the support zone of 72.9-73 doesn’t break, the spot will trade higher towards 73.75,” said Rahul Gupta, head of research (currency), Emkay Global Financial Services.