Just ahead of the Reserve Bank of India’s or RBI policy meet on June 4th, the rupee slipped from its near-one month high to close at 67.11 against the US dollar, while the forex market saw a bit of a lull with currency traders on the sidelines. The dip was due to the demand for the dollar from importers and banks fearing that the RBI will raise the short-term lending rate for commercial banks in June, rather than August. The rate hike will be the first after almost four and a half years, partly as a result of surging crude oil prices. As was anticipated, on June 6th, the Monetary Policy Committee (MPC) announced that it will raise the rates by 25 basis points amid fears of inflation projections.
Sovereign bonds and the rupee turned volatile following the RBI’s unilateral repo rate hike to 6.25% from 6.00%, as forex traders turned shy, with a lull in trading after the central bank’s statement. Although forex traders were certain the new rate would not greatly affect bond yields, sovereign Indian bonds have already been significantly impacted by rising crude oil prices and tighter cash circumstances. As a result, domestic banks, who are the biggest purchasers of bonds, face mounting losses on investments and are temporarily avoiding the securities while selling them off. Bloomberg notes that as banks face mounting losses, hemorrhaging Indian bonds have contributed to making the rupee one of the worst performers in Asia.
In the RBI policy meet, the rate hike does not come as a surprise, echoing movements of its counterparts from other emerging markets, such as Indonesia and Turkey. They too, have raised interest rates to counter a weak currency and tighten capital outflows, as well as to avoid increased inflation and stop the plunge in their local currencies. A post by FXCM suggests that the currency market is a fast-moving one and like most financial markets prices, can vary from minute to minute. As such, extreme currency volatility is to be expected in the current uncertain economic environment. The Economic Times adds that the rate hike, therefore, is seen as a preemptive move by the RBI against the backdrop of such global volatility in crude oil and high commodity inflation, to dampen the rupee’s level as it neared a record low.
Right before the RBI policy meet on June 4th, in the cross-currency forex arena, the rupee dropped against the British pound to finish at 89.79 from a high of 89.34, while also losing against the euro to close at 78.69 compared to 78.41 the previous week. It did, however, remain strong against the Japanese yen, with a strong close of 61.28 per 100 yen, compared to 61.35 from the day before. For a more in-depth look at how major currency pairs are performing, check out our forex chart on Stock Maniacs to get the latest figures. With the RBI hike seen by experts as a “dovish hike,” giving the impression that may not be any more rate increases, fears of a further hike of 25-50 basis points is still predicted if crude oil price and US Treasury yields continue their upward trend.