An incessant torrent of funds rushing into the Indian markets may upset the delicate balancing act of the central bank in 2021.
For most of this year, the Reserve Bank of India has limited currency gains as global investors have poured about $ 50 billion into stocks and shares in companies. This has boosted rupee liquidity in a banking system that is already running out of money through the stimulus resources of RBI.
There is a growing consensus among traders and fund managers that rising pressures – particularly the liquid empty distorted money markets – may prompt the central bank to consider a range of changes, from easing Asia’s worst performance to limiting bond purchases.
A modest gain in the rupee over the past month could mean that policymakers are already marking intervention, or that flows are starting to improve them more.
“We believe the RBI faces a difficult task of managing liquidity while juggling FX flows, buying secondary bond markets to keep long-term borrowing costs low and ensuring that exchange rates are in line with the policy rate,” said Kanika Pasricha, an economist at Standard Chartered Plc in Mumbai. She needs to take steps to implement money market tariffs with political tariffs, she said.
While most currencies in Asia have benefited from a weaker dollar, the rupee has declined 3% this year. Traders show how RBI bought $ 58 billion in the first nine months of the year as signs of its intervention.
Governor Shaktikanta Das has only very broadly commented on the issue, writing in the most recent policy statement that the central bank is acting to mitigate forex volatility and keep the rupee in sync with underlying domestic fundamentals.
Entries to India’s stock market have grown to more than $ 20 billion this year, of course the most year since 2012. Foreign investors have also completed about $ 30 billion in cash acquisitions, according to data compiled by Bloomberg.
Declines in the dollar, forecast to continue to fall in 2021, fuel fund flows to emerging markets globally.
In India, capital flows are expected to reach $ 82 billion by the end of the fiscal year though March, and then continue at the same pace over the next 12 months, according to estimates by Deutsche Bank AG.
“Given the multiple challenges of excessive liquidity due to capital flows and inflation, the RBI may need to reduce intervention and allow for appreciation,” said Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt.
The average estimate compiled by Bloomberg is that the rupee is estimated at $ 72 by the end of 2021. Analysts from Goldman Sachs Group Inc. forecast the currency as strong as 70 by March 2022. It closed trading down 0.1% at $ 73.64 per dollar on Tuesday.
Certainly, some including B. Prasanna, head of global markets, sales, trading and research at ICICI Bank Ltd. argues that when you look at the rupee relative to a basket of its trading partners, the currency is overvalued and the RBI will have little tolerance for it to be strongly strengthened.
With excess money in the banking system valued at nearly 7 billion rupees ($ 95 billion), key overnight rates have fallen below the reverse repurchase rate, which marks the lower limit of the central bank’s political corridor.
Lower shorter rates without a similar drop in long-term borrowing costs mean a steeper yield curve that tends to undermine efforts to provoke growth.
Prices also show that lending rates are falling below similar yields of similar tenor bonds, which is draining profits for banks. If things stay that long enough, it would also cause a mismatch between assets and liabilities in the financial sector, which could spread across a wider economy.
Analysts suggest the RBI will have to deal with the swallowing in early 2021.
Among a multitude of options, it could allow wider access to the reverse rap window, arrange various reverse rap auctions with higher rates and set up a permanent deposit to absorb excess liquidity, according to economists from HSBC Holdings Plc including Pranjul Bhandari
Other options raise the monetary reserve ratio and choose not to replenish a currency that flows out of circulation, they wrote in a recent note.
But there are also fears that these actions could scare debt markets and erode demand for government bonds.
This would be a big problem for the government to sell record amounts of bonds to care for the nation through the coronavirus pandemic.
Against this broader downturn, the central bank this month reminded markets of its ability to deliver surprises.
While the RBI kept the changes as expected at its final policy meeting this year on December 4, it shattered expectations among traders and fund managers that it was ready to squeeze in excess liquidity.
Michael Patra, the influential deputy governor in charge of monetary policy, said this month that the RBI is holding “very careful and close control of the liquidity situation” and is aware that excessive funding in the system can fuel inflation.
The next monetary policy decision is scheduled for February 5, when market pressures may be even higher.
“Options for the RBI to manage and accelerate the recovery is a complex balance of alternatives with economic and financial trade-offs,” said Saugata Bhattacharya, chief economist at Axis Bank Ltd. in Mumbai. “A range of tools will be deployed gradually to gradually drain the liquidity of the system and tighten financial market conditions.”