HYDERABAD: After a hawkish US Federal Reserve increased its policy rate by three quarters, the Reserve Bank of India is likely to follow the suit to keep rupee attractive for foreign investors and fight stubborn domestic inflation.
An interest rate hike in advanced economies like the United States will reduce the interest rate differential in India, which could make non-resident Indians less likely to park their money in India for higher interest income.
Remittances from expatriate Indians is one of the major sources of dollar flow for the country. India was the top recipient of foreign remittances as it received $87 billion in 2021, which is way ahead of countries like China and Mexico.
Remittances could turn crucial when foreign investment into Indian bonds dwindles because of a lower interest rate gap between India and advanced economies. As many as 90 central banks have increased interest rates in 2022, tightening the global money market.
According to sources in Indian banking industry, the RBI’s scheme of liberalised interest rates on foreign currency non-resident (FCNR) deposits in July has not received a great response from NRIs and Persons of Indian Origin. This scheme will end on October 31. A similar scheme, which was announced in 2013 when the rupee was battered because of a sudden tapering of US economic stimulus, had attracted $36 billion in three months.
Lower dollar flow could lead to increased pressure on the rupee, which RBI wants to avoid. While it is nearly impossible to defend a currency’s market rate indefinitely, a lower rupee will translate into higher prices for imported goods like fuel and lead to a poor economic spectacle, which politicians would like to avoid in ahead of elections.
The Reserve Bank has already sold $82.8 billion in 2022 alone to defend the rupee compared to $14 billion that it sold in 2013 when it was affected by the US taper tantrums.
On September 9, India’s forex reserves stood at $550.8 billion compared with an all-time high of $642.4 billion last year. The reserves can now cover about nine months of imports compared to 16 months last year.
“Falling forex reserves, persistently-high commodity prices, limited exchange rate pass-through to inflation and elevated INR valuations will likely tilt the balance towards a less interventionist FX policy in coming months,” Madhavi Arora, lead economist at Emkay Global Financial Services, said in a note. It means the rupee will be allowed to fall, which could lead to higher prices for imported items. Unless geo-political tensions abate, India will have to pay more for petrol in the coming months and the prices of all imported gadgets and gold will increase further.
In a scenario like this, the Reserve Bank will have no option but to increase its policy rate to keep investment in the country attractive for foreign investment. However, any such move will make loans costly and affect demand and slow down the economic growth rate in the country.
A recession in the US economy, which Federal Reserve does not rule out, will also affect earnings from exports and hit the IT industry in the country.
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