RBI’s Rate Hike Not Enough To Support Rupee, Say Experts

Mumbai: With the 25 basis points rate hike by the Reserve Bank of India (RBI) already priced in by the markets, it has failed to make a positive impact on bond yields and the rupee that continue to remain under pressure. Experts suggest that the RBI should keep all options open, including rate increases exceeding 25 basis points to defend the currency against a strengthening US dollar.

For the week, the rupee ended weaker by 42 paise at 96.73 against the US dollar amid the ongoing conflict in West Asia and continued sales by foreign institutional investors. However for the day, the rupee closed marginally up 5 paise snapping a three-session losing streak as softer crude oil prices and a weaker dollar supported the currency.

The Indian rupee is Asia's worst-performing currency this year with a fall of 7 per cent and is very close to its all-time low of 96.96 against the dollar.

Foreign investors during the year to date have pulled out a record $ 24.7 billion from Indian equities this year, while debt flows have turned negative since the beginning of September.

On the other hand, the yield on India 10-year government bond remained at three year high at 7.28 per cent. The yield spread between Indian and the US 10-year treasuries stayed near a 22-year low of 1.94 per cent, or 194 basis points despite the 25 basis points rate hike by the RBI to 5.5 per cent on Wednesday. This was RBI’s first rate hike in four years.

“There has to be some increase in the interest rates in the short term, if not for a longer term, so that a signal is given that you are actually giving a higher risk premium, so that the capital flows into the country and the currency stabilises,” said Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India in a note.

He noted that similar measures had been used in India in 2013, 2020 and 2022. While acknowledging that rate hikes may not be the preferred option for an inflation-targeting central bank, he said some adjustment in the risk premium may be necessary to support the currency.

“The RBI hike was largely priced in, while strong dollar, elevated crude prices (above $ 100 per barrel), persistent FPI outflows and higher US yields continuing to generate significant dollar demand. The markets may be looking for stronger liquidity tightening or direct forex intervention rather than just a rate hike,” said Kunal Sodhani, head treasury at Shinhan Bank.

Meanwhile India’s foreign exchange reserves fell by $12.95 billion to $734.61 billion in the week ended October 2. There has been a decline of over $50 billion in the forex reserves in less than a month. The RBI recorded its biggest-ever weekly forex reserve drop of $18 billion in the week ended September 25. This comes despite a strong response to the FCNR(B) scheme that had garnered around $133 billion.