Treasury Management in Banking
Introduction
In recent months, the Indian rupee has seen notable strength
against the US dollar. The rupee had strengthened nearly 1%
versus the dollar from the peak seen in October 2022. Many
factors, such as declining oil prices, lower commodity prices,
carry trade, and a positive outlook for the economy, have
contributed to the rupee’s rise in value. Yet, the Reserve
bank of India’s (RBI) monetary policy is one of the most
significant elements driving the Rupee’s increase.
The acts done by a Central bank to affect the cost and
availability of credit in an economy are referred to as
monetary policy. The monetary policy of the RBI is intended
to support the rupee by limiting inflation, preserving
sufficient foreign exchange reserves, and fostering economic
expansion.
By regulating interest rates, the RBI supports the rupee in
several important ways. As the RBI reduces interest rates,
borrowing money is more affordable for both businesses and
individuals. This in turns boosts economics activity and may
result in higher rupee demand. On the other hand, when the
RBI increases interest rates, borrowing money becomes more
expensive, which might impede economic growth and lower
demand for the rupee.
Because of persistent higher inflation (above the tolerance
limit of 6%), the RBI has been increasing interest rates in the
last year (the repo rate hiked from 4% to 6.5% over the last
12 months).
RBI rate hike help stem the rupee slide
Money can have various forms – commodity money, fiat
money or commercial bank money. Commodity money is the
one that has its own value and is employed as a medium of
exchange. Gold, cocoa or cattle fall in this category. Central
banks around the world still do some form of currency
exchange in gold. Fiat money is the one that does not have
anny intrinsic value but governments declare it as legal
tender. Fiat money can be used to discharged any public or
private debt. Modern-day monetary systems are based on
fiat money.
Cheques, demand drafts and banker’s drafts are called
commercial bank money.
The value of a currency unit determined
The value of rupee against the dollar or for that matter any
other other currency depends on the market forces of
demand and supply.
If the demand for dollar increases, then the value of rupee
depreciates and vice-versa. For example; If the import
demand has risen, which requires payment in foreign
currency, then the domestic currency will weaken.
Some of the other factors that influence the value of rupee:
1. Inflation
2. Interest rates
3. Trade deficit
4. Macroeconomic policies
5. Equity market
What role does RBI play?
The Reserve bank of India intervenes in the currency market
to support the rupee as a weak domestic unit can increase a
country’s import bill. In contrast, a weak rupee is considered
good for exports, which is why exports-dependant nations
love to keep the currency low.
There are a variety of methods by which RBI intervences. It
can intervene directly in the currency market by buying and
selling dollars. If RBI wishes to prop up rupee value, then it
can sell dollar and when it needs to bring down rupee value,
it can buy dollars.
The central bank can also influence the value of rupee by the
way of monetary policy. RBI can tweak the repo rate (the rate
at which RBI lends to banks) and the liquidity ratio (the
portion of money banks are required to invest in government
bonds) to control rupee.
The aim of the Reserve bank is to ensure that a weak rupee
doesn’t increase the already bloated import bill.
RBI’s rate hike/ cut influences rupee
The repo rate is an instrument used by the Reserve Bank of
India to control inflation. It is the rate at which the central
bank (Reserve bank of India) lends money to commercial
banks in the event of any shortfall of funds.
Higher interest rates in an economy tend to draw foreign
investment, increasing the demand for and value of the
home currency. Similarly, lower interest rates tend to
decrease exchange rates.
RBI can raise the repo rate, which leads to a rise in interest
rates, bond yield and return on debt papers, drawing more
investors money to chase better returns if the same is low in
other markets. On the other hand, higher interest rates stem
money circulation in the economy, leaving more money in
the hands of RBI to manage the currency demand- supply
situation.
Also, the currency value drops, it tends to drive up inflation,
as imported goods become costlier. By raising interest rates,
the central bank can lower demand for such goods, leading
to pressure on prices.
Hike in repo rate : A hike in repo rate acts as a disincentive
for banks to borrow from the central bank and is employed
by RBI to control money circulation and thus rein in inflation.
A higher repo rate can reduce money supply in the economy
and thus help arrest price rise.
Cut in repo rate : When RBI cuts repo rate, banks need to pay
less interest on their borrowings from RBI. Thus, banks also
charge less on their loans and it thereby raises money
circulation, which leads to price rise and increase economics
activity.
Long term impacts of currency devaluation and depreciation:
1. The long-term impacts of devaluation and depreciation
differ.
2. The depreciation of the domestic currency in a floating
exchange rate regime, can increase its exports, boost
spending and can make the economy look better for the
foreign investors.
3. This can increase the flow of foreign investment which
can cancel out some of the effects of depreciation.
4. However, this is not possible in a fixed rate economy as
only the government or central bank change the
exchange rates.
Ans 2)
