RBI likely active near 90 to dollar via state-run banks, traders say

The recent intervention by the Reserve Bank of India (RBI) in the foreign exchange market, selling US dollars through state-run banks to prevent the Indian Rupee (INR) from breaching the 90-per-dollar mark, offers a crucial case study for understanding India's economic policy and central banking functions. This action is not an isolated event but a strategic move rooted in the RBI's mandate to maintain financial stability and manage inflation.

**Background Context:**

India operates under a 'managed float' exchange rate regime. This means the rupee's value is primarily determined by market forces (demand and supply), but the RBI retains the right to intervene to curb excessive volatility or align the currency with broader economic objectives. The pressure on the rupee to depreciate stems from a confluence of global and domestic factors. Globally, a strong US dollar, often driven by the US Federal Reserve's hawkish monetary policy (raising interest rates), makes dollar-denominated assets more attractive, leading to capital outflows from emerging markets like India. Rising crude oil prices, a significant import for India, also exacerbate the demand for dollars. Domestically, a persistent current account deficit (CAD), where India's imports of goods and services exceed its exports, creates a structural demand for foreign currency. The psychological threshold of '90' per dollar becomes a critical point, as breaching such a round number can trigger panic selling and further depreciation, creating a self-fulfilling prophecy.

**What Happened:**

On Friday, as the rupee approached the crucial 90-per-dollar level, trading around 89.98, market participants observed state-run banks actively selling US dollars. This is a classic form of direct intervention by the central bank. By selling dollars, the RBI increases the supply of dollars in the market, which helps to strengthen the rupee by making it relatively more scarce. This action directly counteracts the depreciation pressure and instills confidence among traders that the central bank is actively monitoring and managing the currency's trajectory. The use of state-run banks as intermediaries is a common practice, allowing the RBI to execute its market operations without directly revealing its full hand, thus maintaining an element of surprise and effectiveness.

**Key Stakeholders Involved:**

1. **Reserve Bank of India (RBI):** The primary stakeholder, responsible for monetary policy, financial stability, and managing foreign exchange reserves under the Reserve Bank of India Act, 1934. Its intervention reflects its commitment to these mandates, particularly price stability and orderly market conditions.

2. **State-run Banks:** Act as agents for the RBI, executing dollar sales on its behalf. They play a crucial role in transmitting the central bank's policy actions to the broader market.

3. **Forex Traders and Market Participants:** Their buying and selling decisions collectively determine the rupee's value. They constantly watch for signs of RBI intervention and adjust their positions accordingly.

4. **Importers and Exporters:** Importers face higher costs when the rupee depreciates (e.g., imported oil, machinery), potentially leading to higher domestic prices. Exporters, conversely, might benefit from a weaker rupee as their goods become cheaper in dollar terms, though this benefit is often offset by higher import costs of raw materials.

5. **Government of India:** A stable rupee is vital for the government's fiscal planning, managing external debt, and controlling inflation, which directly impacts public welfare.

**Why This Matters for India:**

This intervention holds significant implications for India's economy. Firstly, **inflation management** is paramount. A depreciating rupee makes imports, especially crude oil and other essential commodities, more expensive. This 'imported inflation' can undermine the RBI's primary mandate of maintaining price stability, as formalized by the Monetary Policy Framework Agreement (2016), which targets a 4% Consumer Price Index (CPI) inflation with a +/- 2% band. Secondly, a rapidly weakening rupee can worsen India's **current account deficit (CAD)** and **balance of payments (BoP)**, as the import bill swells. Thirdly, **foreign investment** (FDI and FII) can be deterred by currency volatility, as it introduces uncertainty and potential losses for investors. Finally, a stable currency is crucial for **financial stability** and overall economic confidence, preventing capital flight and maintaining the creditworthiness of Indian entities with foreign debt.

**Historical Context and Broader Themes:**

India has a history of managing currency volatility, notably during the 1991 balance of payments crisis, the 2008 global financial crisis, and the 2013 'Taper Tantrum,' when the rupee faced severe depreciation pressures. Each time, the RBI employed a mix of monetary policy tools and direct forex intervention. This current intervention aligns with the broader theme of central bank autonomy and its critical role in safeguarding national economic interests against global headwinds. It also highlights the intricate link between domestic monetary policy, global economic trends, and India's external sector.

**Future Implications:**

The RBI's intervention signals its resolve to prevent runaway depreciation. However, continuous intervention can deplete India's foreign exchange reserves, which stood at approximately USD 640 billion as of early June 2024. A substantial depletion could limit the RBI's future ability to intervene and might send negative signals to the market. If global dollar strength persists, or crude oil prices remain elevated, the RBI might be forced to consider other measures, such as raising interest rates, to attract capital and support the rupee. While interest rate hikes can support the currency, they also carry the risk of slowing down domestic economic growth. The government's role in managing fiscal deficits and promoting exports through policies like the Foreign Trade Policy (FTP) also becomes crucial in reducing the structural demand for dollars and alleviating pressure on the rupee.