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Rupee will strengthenATN News

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Recent interest rate hikes US Federal Reserve and the Swiss central bank (ending an era of negative interest rates in Europe) demonstrate the new resolve of central banks in developed economies to bring inflation under control. The US Fed has been slow to pick up on signs of rising inflation and its temporary nature. But keeping pace with faster and sharper rate hikes could get rid of the refrain for the time being. The Fed dot plot now shows that rates could continue to rise to 5 percent in 2022 and even into 2023. This is a worrying number for global markets.

The situation was worsened by the fact that major central banks – the European Central Bank, the Bank of England and the Bank of Japan – lagged behind US expectations in the pace of rate hikes, sending the dollar index to its highest level in 20 years. . This is one of the few times when the currencies of developed economies see more weakness than those of emerging market economies. The euro, breaking parity, is trading at a two-decade low and could inch toward an all-time high of 0.8231 seen in October 2000. Another major currency, the yen, is below its 1998 lows, prompting the Bank of Japan. Intervening in markets on Thursday for the first time since June 1998, to protect the crucial stable 145. The pound could see further weakness. A checkered political landscape and adverse weather conditions pushed the dollar to its 1985 low of 1.05. For the currencies of emerging market economies, the fall during the turmoil was less, a reversal of the trend observed during the crisis. This “relative” performance of emerging economies like India is often ignored by purists when they provide an abstract value for currency depreciation.

Against this volatile backdrop, the rupee crossing 80 against the US dollar was inevitable. So far the RBI has protected the currency from crossing this psychological threshold and kept volatility under control. However, the rupee has slipped past 80 after the recent hike by the US central bank and the dot plot hinting at the possibility of a terminal rate of around 5 percent. No central bank can prevent currency devaluation at this point. In this context, the RBI may allow the rupee to depreciate, but only for the time being. The currency appears even more overvalued when weighed against the real effective exchange rate and the nominal effective exchange rate.

Also, the RBI has already used about $75 billion of foreign exchange reserves after the Ukraine war to prop up the rupee. As a result, the import coverage has decreased for nine months. There is always a trade-off in using forex reserves to hedge the currency. This position may be justified because the rupee’s weakness was caused by a strong dollar and not India’s domestic economic fundamentals. The rupee has depreciated 6.7 percent against the US dollar since the war broke out, while the dollar index has risen 15 percent. This means that the rupee will bounce back strongly once the dust settles – research shows that after a fall, the rupee inevitably makes a strong comeback. This is a reasonable assumption in the current scenario as India’s macroeconomic fundamentals are strong enough to warrant a rebound.

However, the best thing that could have happened to India after the Ukraine war – the precursor to a new India in the making – was a strong performance in stocks. A resumption of overseas portfolio flows is a “distinctly Indian” theme. Markets have not fallen as much compared to the fall in developed economies. There was no panic when the FBI retired some of its funds earlier this year. Portfolio inflows revived strongly in August and inflows of $10 billion in September – 68 per cent outflows in April-July. This “decoupling” is a harbinger of things to come.

Another disconnect is that even as global yields go through the roof, domestic yields remain constrained over the long term. These developments are new to conventional macroeconomics wisdom.

The truncated story is not an outlier, however. With private participation in new investment announcements (around 70 percent), supported by strong corporate and household balance sheets, economic prospects appear to be on track. The MSME sector, the surrogate of the informal economy, has proved the naysayers wrong. The latest data captures the sector’s resilience, first faced with the pandemic, and now with slippages nowhere near the levels expected some time ago. In fact, even the net NPA levels of MSMEs (without any provisioning) are within the comfort zone of banks. Collections are improved and accounts are improved where possible.

We end with an interesting story. 2021-22 saw record growth in home loan disbursement. It continued in 2022-23. Demand is increasing from Tier 3 and Tier 4 cities, where women account for a large proportion of borrowers. Part of this growing demand for home loans in such cities can be attributed to the SVAMITVA scheme, which acts as a force multiplier for rural residents with the right to document their residential property, which they did not have earlier. This shift in demand towards small towns augurs well for building better social infrastructure in education/health facilities in the future. Increasing participation through digital sachis under National Rural Livelihoods Movement/State Rural Livelihoods Movement has led to significant behavioral change through faster financing of women. Clearly, there is disconnect here too – a welcome change from the hitherto male-dominated loan book of financial institutions.

Panel of Editors Chief Economic Adviser, State Bank of India. Views are personal


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