The Reserve Bank of India (RBI) has continued to keep interest rates low. The current repo rate, the rate at which the central bank lends money out to commercial banks, is 4%. The RBI kept interest rates unchanged in December 2021 and once again in February 2022. This is because the Ministry of Finance is building in an “escape clause,” allowing inflation to increase above the target goal of 4%. The RBI has a band of 2 to 6% for inflation, which acts as a window for the RBI to keep inflation rates low.
The RBI’s decision to maintain low rates has had several implications for the rupee and forex trading. First, the RBI’s increased pumping of liquidity is weakening the rupee on a domestic level and against the dollar. Second, rate hikes by major central banks has led to increased volatility and weakness for the rupee. Third, although the rupee saw a sharp acceleration at the end of Q4, rising oil prices further deprecated the rupee against the dollar. Fourth, since India is the third-largest oil importer, rising oil prices have widened the balance of trade, leading to greater weakness in the rupee.
Several countries’ central banks are hiking interest rates to combat spiraling inflation. The Bank of England has hiked rates three times, and the Federal Reserve conducted its first rate hike in March 2022. As a result, the rupee has had a broader weakness against other major currencies.
The RBI has been pumping liquidity into the market by keeping interest rates low. This is because the RBI seeks to promote economic growth despite other countries’ plans to tighten rates. First, this policy is weakening the rupee on the domestic level. Second, increased liquidity of the local unit decreases the value of the rupee against the US dollar. The RBI’s monetary policy, combined with external factors like rising oil prices, has led to a negative outlook for the rupee in forex trading.
Rupee ended 2021 Q4 on a high despite an extremely tough December
As major central banks signaled higher interest rates, it generated volatility for the rupee. Rate hikes would result in less global liquidity. The rupee has been under pressure since November when the Fed first signaled rate hikes and an accelerated tapering schedule. The rupee depreciated 2% between mid-November and mid-December.
Toward the end of December, however, the rupee sharply turned around and gained 24% against the US dollar. The sharp appreciation at the end of December was a function of technical factors and shallow volumes going into the new year. Despite the positive momentum, several investors estimated that it would not last amid concerns about rising oil prices and India’s widening monthly trade deficit.
The dangers of rising oil prices on the Rupee
Elevated oil prices have caused imported inflation in conjunction with already spiraling inflation in India. Rising oil prices have further depreciated the rupee against the US dollar. This has impacted forex trading.
The sharp increase in oil prices does not bode well for the rupee because India is the third-largest importer of oil in the world. Riskier assets took a hit amid mounting and lingering Russia-Ukraine tensions due to the possibility of disruptions in energy supplies. However, government intervention has aimed to keep rising crude oil prices from impacting domestic retail inflation.
India’s widening balance of trade as a result of rising oil prices
India’s balance of trade is dependent on rising oil prices. India’s widening trade deficit is a red flag for the rupee by putting downward pressure on the currency. India’s trade deficit widened to 18.7 billion USD in March 2022. The reading was 13.9 billion USD in the same period during the previous year. Imports also significantly exceeded exports. While exports rose 17.2% to 40.4 billion dollars, imports surged 22.1% higher. The rupee has faced increasing weakness due to the RBI’s low rates.
The bottom line
The RBI’s decision to maintain low rates has had negative effects on the rupee in forex trading. First, increased liquidity is depreciating the rupee on a domestic level and against the dollar. Second, major central banks such as the Federal Reserve and the Bank of England conducted and announced rate hikes at future meetings, which has led to increased volatility and weakness for the rupee. Third, despite the rupee’s surprisingly sharp acceleration at the end of Q4 due to technical factors, rising oil prices further
caused weakness for the rupee against the dollar. Fourth, rising oil prices have widened the balance of trade in India, leading to greater weakness in the rupee. This scenario is due to the fact that India is the third-largest oil importer in the world. – Bloomberg.
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Source: The Print
