An incessant torrent of funds rushing through Indian markets could tip the delicate balancing act of the central bank in 2021.
For most of this year, the Reserve Bank of India capped foreign exchange earnings as global investors invested around $ 50 billion in shares and stakes in companies. This has increased the rupee’s liquidity in a banking system that is already full of cash from the RBI’s stimulus measures.
There is a growing consensus among traders and fund managers that growing pressures – especially the lack of liquidity that distort money markets – may stimulate the central bank to consider a number of changes, from easing control over the most important currency. poor performance in Asia to the point of reduced bond purchases.
A modest gain in rupees in the last month could mean that political decision-makers are already pulling out the intervention or that inflows are starting to get better.
“We believe that the RBI faces a difficult task of managing liquidity as it juggles foreign exchange inflows, bond purchases in the bond market to keep long-term borrowing costs low and to ensure that money market rates are aligned with the policy rate, “said Kanika Pasricha, an economist at Standard Chartered Plc in Mumbai. Steps must be taken to align money market rates with policy rates, she said.
While most Asian currencies benefited from a weaker dollar, the rupee fell 3% this year. Traders point out how the RBI bought $ 58 billion in the first nine months of the year as signs of its intervention.
Governor Shaktikanta Das made only a very broad comment in this regard, writing in the latest policy statement that the central bank is acting to reduce currency volatility and keep the rupee in sync with domestic fundamentals.
India’s stock market inflows have risen to more than $ 20 billion this year, of course, mostly on an annual basis since 2012. Foreign investors have also completed about $ 30 billion in cash purchases, according to data compiled by Bloomberg.
The dollar’s decline, which is projected to continue to decline in 2021, is fueling cash flows to emerging markets globally.
In India, capital flows could reach $ 82 billion by the end of the fiscal year, however, in March, then continue at the same pace for the next 12 months, according to estimates by Deutsche Bank AG.
“Given the multiple challenges posed by excess liquidity due to capital flows and inflation, the RBI could be forced to reduce intervention and allow for appreciation,” said Arvind Chari, head of fixed and alternative income at Quantum Advisors Pvt.
The median estimate compiled by Bloomberg is that the rupee will appreciate at $ 72 by the end of 2021. Analysts Goldman Sachs Group Inc. forecasts the currency as strong as 70 by March 2022. It closed trading down 0.1% to 73.64 per dollar on Tuesday.
Certainly, some of them, including B. Prasanna, head of global markets, sales, trading and research at ICICI Bank Ltd., argue that when you look at the rupee against a basket of its trading partners, the currency is overvalued and the RBI will he had little tolerance for it to suddenly strengthen.
With the excess cash in the banking system estimated at nearly 7 trillion rupees ($ 95 billion), key overnight rates have fallen below the reverse repurchase rate marking the lower end of the central bank’s political corridor.
Lower rates, without a similar decline in long-term borrowing costs, mean a steeper yield curve, which tends to undermine efforts to stimulate growth.
The price also indicates that lending rates are falling below similar yields on tenor bonds, which reduces profits for banks. If things stay that way long enough, it would also cause a mismatch between assets and liabilities in the financial sector, which could evolve into a wider economy.
Analysts suggest that the RBI will be forced to address the shortfall in early 2021.
Among a number of options, it could allow wider access to the reverse repo window, could organize variable reversal repo auctions at higher rates, and could create a permanent deposit facility to absorb excess liquidity, according to economists. at HSBC Holdings Plc, including Pranjul Bhandari.
Other possibilities are increasing the rate of cash reserves and choosing not to fill the currency that flows out of circulation, they wrote in a recent note.
But there are also fears that taking such action could lead to fears of debt markets and erode demand for government bonds.
This would be a big problem with the government selling record amounts of bonds to care for the nation through the coronavirus pandemic.
Against this larger decline, the central bank reminded the markets this month of its ability to offer surprises.
While the RBI kept rates unchanged, as expected, at its final policy meeting on December 4, it rejected expectations among traders and fund managers that it would be ready to start absorbing excess liquidity. .
Michael Patra, the influential deputy governor responsible for monetary policy, said this month that the RBI is watching “very closely and carefully the liquidity situation” and is aware that excess funds in the system can fuel inflation.
The next monetary policy decision is scheduled for February 5, when market pressures may be even greater.
“The options for the RBI to manage and accelerate the recovery represent a complex balance of alternatives that involve economic and financial trade-offs,” said Saugata Bhattacharya, chief economist at Axis Bank Ltd. in Mumbai. “A number of instruments will be deployed incrementally to gradually drain system liquidity and tighten financial market conditions.”