How Does One Read RBI's Forex Strategy? Look At The Yuan

In the recent weeks, the linkage between the rupee and yuan has been more pronounced than the dollar, as it defines India's export competitiveness compared to its trading partners, currency traders said.

"We are now more pegged to CNY, as compared to USD, because if we look at three-month chart, we are moving in tandem with what is happening in China, as compared to dollar index or any other currency," Abhilash Koikkara, head of forex and commodities at Nuvama Group.

"We are definitely trying to keep a narrow range with Chinese yuan so that our export competitiveness does not get hit," he added.

The yuan/rupee exchange rate stood at 11.50 on Wednesday, compared with 11.52 a month ago.

A senior treasury official at a large private bank believes that the pattern of the RBI's intervention strategy indicates that it might want to keep the yuan/rupee pair at around 11.50.

On March 22, the Chinese yuan weakened against the US dollar, breaching the psychologically crucial 7.2 per dollar on the back of expectations of further easing in monetary policy. This dragged the Chinese yuan to the lowest level since Nov. 17, 2023.

For India, a fall in yuan's valuation against the rupee would only encourage more imports from China, as products become cheaper. At $83.2 billion in 2022-23, India's trade deficit with China accounted for a little over 30% of the home country's overall trade deficit. Experts believe this will likely widen if rupee keeps in tandem with the yuan.

"I don't think that is a very palatable scenario if India is trying to build domestic capacity in manufacturing exports," said Dhiraj Nim, economist/FX strategist at ANZ Banking Group said.

Global dollar strength weighed on other Asian currencies too, which makes a case for a similar depreciation in the Indian rupee as well. On Wednesday at the time of writing, the rupee stood at 83.16 per dollar, compared with Tuesday's close of 83.32.

In the monetary policy statement on Apr 5, RBI Governor Shaktikanta Das resolved to maintain robust foreign currency reserves, like how they have been over the last many months by purchasing dollars from the dollar/rupee market.

As of March 29, India’s foreign exchange reserves reached an all-time high of $645.6 billion, up $67.2 billion from a year ago.

In terms of the rupee, the RBI governor said that the domestic currency has remained largely range-bound in FY24, in comparison with emerging market peers such as the Chinese yuan, Thai baht, Indonesian rupiah, Vietnamese dong and Malaysian ringgit. The rupee was most stable, falling by a mere 1.4% against the dollar, as compared with a few advanced economy currencies like the Japanese yen, Korean won and New Zealand dollar as well.

"As compared to the previous three years, the INR exhibited the lowest volatility in 2023–24. The relative stability of the INR reflects India’s sound macroeconomic fundamentals, financial stability and improvements in the external position," Das had said.

The RBI's interventions in the currency market are guided by the intent to ensure stability in the rupee, as per their stated stance.

Although, this is not the first time that the RBI is speculated to have based their interventions in the forex market depending on the movement in yuan/rupee pair.

Back in 2019, the central bank was said to have stepped up the gas on its dollar-buying interventions as they wanted to maintain the yuan/rupee exchange rate around 10, according to traders. In September, the rupee hovered in the range of 70.34-72.40, implying a trading range of 206 paise through the month.

When compared with the volatility now, the trading range in March 2024 was 81 paise. In February, the range was just 30 paise.

The rupee did not rise beyond the September's low of 70.34 ever, as the RBI's persistent dollar-buying interventions then had put a hard stop on the upward trajectory. By the end of 2019, the rupee had lost 0.7% against the greenback.

India's strong macroeconomic fundamentals along with higher foreign fund inflows owing to the JP Morgan bond inclusion has kept the rupee on a slightly higher footing.

Towards the end of the financial year, pick up in large corporate outflows as well as global dollar strength led to weakness pressure in the currency, registering a record low of 83.45 a dollar in onshore trade on Apr. 4.

In offshore trade, the rupee plunged to as low as 83.72 a dollar on March 22.

The most appropriate measure to assess export competitiveness is the RBI's nominal effective exchange rate, or NEER. In February, the NEER stood at 94.4, compared with 93.24 in the previous month.

An increase in a country's NEER indicates that it is losing its trade competitiveness.

Going forward, the rupee is likely to take cues from the movement in Chinese yuan and Japanese yen, traders said.

"If JPY and CNY depreciate against the dollar just to keep the export competitiveness, the RBI might let the rupee float in this range between 83-83.70 before any decisive comeback," Koikkara said.

With expected foreign fund inflows and improved market sentiment against the backdrop of upcoming elections, currency market participants have learned the lesson to hedge their forex exposure and not be complacent, traders said.