The zigzag movement of the Indian Rupee value could become a rare sight soon. The RBI has been working on a strategy to straighten out currency volatility. More than the appreciation or depreciation, the Rupee volatility affects investors, exporters, and importers. Frequent fluctuations of high magnitude in exchange rates often create panic or euphoria giving rise to unwarranted speculation on the direction of the currency’s movement. This speculation often leads to excessive volatility, worsening the matter. Lower inflation and active interventions of RBI in the currency markets have made it possible for India to ride out a difficult phase of appreciating US$. The RBI wants to bring the volatility in INR down further.

The RBI has identified powerful tools to achieve the Rupee stability—Inflation Targeting and Liquidity Management. Let’s see what Dr. Raghuram Rajan, the RBI Governor, said about the strategy to achieve exchange rate stability. Addressing the Media, he said, “Our aim in the macro stabilisation is to make the exchange rate less and less an issue that investors have to worry about.” He further added that “If we move towards our inflation target of around four per cent, then the past years where you had extreme volatility in the rupee because rupee inflation in India was much higher than the world, will become a thing of the past.”

In simple words, the Indian Rupee maintains its competence only when domestic inflation is in line with the global trend. If the national economy has an excessively higher inflation as compared to that in a country from where the foreign capital flows into India, the Rupee is likely to depreciate more, and the reverse is also true. Currency appreciation or depreciation, in this case, reflects the difference in the real purchasing power of the traded currencies. This essentially tells us that, currency depreciation in nominal terms is not always bad, if the domestic inflation is low. In such a case depreciation in the value of the currency may make exports more competent. Over last two financial years, India’s currency has moved in a range of 18.0%.

Besides inflation, managing systemic liquidity concerns is crucial to curbing the currency volatility. In the first bi-monthly monetary policy for FY 2016-17, the RBI underscored its intent to manage liquidity at two stages. While the Central Bank is keen on addressing the need for short-term liquidity by injecting or absorbing liquidity, the new liquidity management policy of RBI aims to end the long-prevailing practice of maintaining a specific amount of deficit in the system. Now the RBI wants to ensure that the system always remains in a neutral position (with no liquidity gap). Such policies help to keep the exchange rate stable.

PersonalFN is of the view that lower volatility on the exchange rate front may make India handle the FII outflows better. We’ve seen capital markets benefit through predictable currency movements and this has been a positive development for Indian investors. However, PersonalFN cautions you against speculating on the currency or the capital market movements. Investing for the long term may assist you in fulfilling your financial goals.
 

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