A collapse in imports during the coronavirus lockdown has left India awash with dollars. Now a further influx of greenbacks is expected as an embryonic economic recovery draws investors back. To banks, this means one thing: The local currency is a sitting duck for appreciation against a weakening dollar.
Policy makers won’t want a stronger rupee to become a one-way bet, but the market doesn’t believe them to have many other options. What the authorities have done so far — scoop up the dollars by giving banks rupees — has left the financial system swimming in money and threatens to fuel inflation that’s already above the central bank’s target. It’s a mirror image of China, where a spate of corporate defaults has squeezed interbank liquidity.
While China’s recovery from the pandemic has made it the first major economy to consider exiting emergency economic measures, in India, monetary stimulus is still very much the only game in town. If the Reserve Bank doubles down on its generosity in 2021, the country’s red-hot equity markets could get dangerously overvalued. Conversely, if the RBI pulls back on liquidity — before the complicated task of distributing vaccines to