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| Edited By: Ananth Narayan |Source: DNA |Updated: Mar 22, 2018, 03:16 AM IST
The best time to prepare for financial instability is when things are calm – as they seem in INR now.
The FCNR repayment has been smooth so far. Medium term, our current account deficit (CAD) continues to benefit from low oil prices. India remains an attractive destination for capital inflows.
As ever, there are risks and vulnerabilities. INR is now over 16% overvalued on the 36-country real effective exchange rate (REER). This reflects ongoing USD strength, which has now seen USDCNY quietly move above 6.75. Headline USDINR is not the right metric for judging INR strength.
With a young, underemployed population, India can ill-afford a strong currency, that cheapens imports and impedes Make in India. The RBI focusses on REER over the medium run, and at 16% overvaluation we are testing some boundaries.
Since 2014, our unhedged foreign currency exposures have increased.
As the balancing figure, RBI’s net intervention in FX spot and forwards markets should be the sum of our current account position, net foreign direct investment (FDI) flows, and the change in FX exposures of the market.
Capital flows across external commercial borrowings (ECB), NRI deposits, and foreign portfolio investments (FPI) should not add to RBI’s intervention, unless someone is assuming an FX risk.
In FY15, across current account and FDI, the net number was an inflow of about $5B. However, RBI’s actual spot and forward intervention was a net purchase of $96B. This indicates that the market increased its unhedged foreign currency exposures (across unhedged ECB, hedged exports, and unhedged FPI) by a whopping $91B.
In FY16 and FY17 till June 2016, however, while FDI and CAD amounted to an inflow of $18B, the RBI net sold $2B across spot and forwards. With the increase in global volatility, encouragingly, unhedged INR exposures were reduced by $20B.
Yet, since 2014, with improved sentiment, high hedging costs and a relatively stable INR, the market has increased its unhedged exposures by $70B.
Globally, risks still abound. Global growth remains brittle. Vulnerabilities remain in China, Europe and elsewhere. Politics, geopolitics, and central banks continue to grab headlines. Commodity prices have been volatile. There is limited ammunition to handle another crisis.
In the recent past, USDINR FX forward premium have dropped. It would be prudent to take advantage of this and purchase outright or option protection, to reduce unhedged currency exposures. If the system is better prepared, the next crisis may never come.
The writer is regional head of financial markets for Asean & South Asia of Standard Chartered.
