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Why is Rupee Unusually Appreciating Against the Dollar?

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In response to my earlier article on capital expenditure and costs I got a very good query enquiring as to why rupee is appreciating against the dollar. The reader Ms. Swetha Pabbu was good to point out that this is against the normal trend. Normally as all of you may be aware we see a depreciation in rupee most of the times.

SO this week we will discuss about the recent appreciation of Rupee to dollar and outline what we believe RBI’s role in forex management and RBI’s responsibility as the debt manager for the government.

Finally we will also discuss the implication of this foreign exchange movements (forex) on our businesses and the strategy to be adopted while hedging the FX exposures of a business.

Let us first begin by understanding RBI’s Role in Forex Market

Normally RBI buys dollars from the market which results in increased rupee liquidity. The Increased supply of rupee without a corresponding demand makes the rupee depreciate against the dollar. Thus buying and selling of dollars is one of the ways to increase or contract the supply of rupee in the market. RBI uses this tool of buying and selling to keep Indian exports competitive in the international markets, to build strong forex reserve and to negate actions of foreign Central Banks.

On this backdrop its pertinent to note that the since March 2020 RBI has accumulated more the 62 billion US dollars and total reserves stands at more than $530 billion, the fifth largest in the world. This was mainly done because RBI was on a streak to increase the liquidity in the economy and ease the pressure build up by the COVID 19 pandemic.

However the million dollar question asked by business persons is whether RBI loosening the reins on the Rupee?

Many are asking this question given the recent appreciation of the rupee.

The record inflow of dollars through Foreign Portfolio Inflows (FPI) and other modes have increased the demand for rupee. This has led to Rupee appreciating against the dollar.

Coupled with the above, as discussed in a previous article the RBI is also concerned about the increased headline inflation. And as we know increased liquidity also increases inflation. Thus our view is that RBI may not further buy dollars from the markets till the time uncertainty looms around its inflation target. Also RBI won’t do much to arrest this appreciation as this will help in reducing the import cost and also keeping in check Cost pushed inflation and inflation related to recent supply chain disruptions.

In conclusion in the short term we believe that the rupee will appreciate against the dollar or to say the least be guided by the market forces as the RBI won’t intervene much- to keep inflation within its range bound target. Thus in our analysis in the short term the rupee will appreciate against the dollar for some time. However in the long term RBI will ensure a depreciation of rupee to help exporters. What no one will be able to predict is the timing and possible future trends.

Strategy for Business who have Foreign Exchange (Forex) Exposures

Given the situation we have advised all our clients as below:

Exporters are advised to sell their exposure in tranches or whenever the Rupee depreciates above the 74.5 mark. Also it is advisable to hedge more than 70 % of forex exposures.

For business with import bills, they can hedge their exposure by buying a call option in order to keep the downslide open.

This is our considered view keeping in mind all available information. However request all business persons to take their own decision after considering all pertinent factors. Predicting currency movements is very tricky given the black swan events hence we believe that it is best for a business person to hedge and insure the business against the volatility of currency movements.

(Sincere thanks is due to CA Abhay Nair for contributing significantly to this article by taking part in the discussions)

Read the article in Malayalam

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Dr Anil R Menon
Dr Anil R Menon  

Dr. Anil R. Menon is a PhD in Strategy & a post-graduate in Finance. An Engineer by graduation he is a business consultant to leading companies in India and abroad. He also loves mentoring entrepreneurs and his videos can be accessed on YouTube channel menonmantras

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