Fluctuating Indian Rupee: Cause and Consiquences

Fluctuating Indian Rupee

Introduction

The past month has been disastrous for the rupee value against dollar currency. The same time last month (22-Aug-2011), rupee value against dollar was 44.5 – 45.0 range; today it is hovering to the range of 49.0 – 50.0. It is expected to rise further which would result in weakening the rupee value against the dollar currency. This kind of increase would have the drastic impact on the macro economy of the country like heavy raise in the import cost where countries like India heavily depends on the importing on Oil and other crucial raw materials needs for the industries.

This article explores the reason behind the rupee value depreciation, how RBI trying to defend the rupee value and how it is going to affect the industries. If you have any thoughts, please post it in the comments section. 

How currency value is determined?

We are not going deep dive into economic terms to understand the currency value fluctuation. There are many factors to decide the currencies values but that could be very difficult for the common man to understand the theory. Here I will put it in the simple words why the currency value is often fluctuated. A currency will tend to become more valuable when its demand is higher than supply. A currency will tend to become less valuable when its demand is less than supply. It is the basic theory. We need to understand in the global economy terms, when the currency will have more demand and when it will have less demand.

Remember that exchange rates are expressed as a comparison of two currencies. It is always relative and can be measured between two countries. To know more about currency market click here

Interest rates, Inflation and exchange rates are highly related. Reserve bank changes the interest rates to control the Inflation and exchange rates. We can take our real time example of stock market investment to understand the above principle. As we know that, our stock market is dominated by the overseas investors (outside India), because of our growing economy and industrial development. When our economy is doing well and market is performing better than other countries, overseas investors would invest heavily on our market. How they would put it in our market?. They will sell or convert to our currency and invest in India. It is clear that when more investors coming to India, the demand for the currency will be very high. Our rupee value will be increased against dollar. In the same way, when they are pulling out of market, demand for the rupee will be decreased and value is depreciated.

Here I am talking only about the dollar, because it is the global currency and most of the countries trading using the dollar as trade reserve currency. The above example is given to explain it in simple words, the demand for a currency would come in the different way. When we are importing from other countries, we should have the currency of that country to pay for the trade. The value for the currency is fluctuated on real time.

If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly on financial markets, mainly by banks, around the world.

 A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan renminbi (CNY, ¥) was pegged to the United States dollar at ¥8.2768 to $1.

Why RBI intervene on Currency valuation?

In the last week we have seen RBI has acted to stop the erosion of rupee value against the dollar currency. What it did was  sold the dollar currency in the market to increase the value of rupee. But, it is very difficult for the Reserve Bank of a country to adjust the value of the currency, the long term solution would be fix the problem in economy and bring the inflation into control. You would wonder why RBI has to intervene on currency value decrease or increase. Note that, RBI would not allow currency to be higher after certain level because of the exports would get affected like IT companies would suffer if the rupee gets appreciated against the dollar. To know more about this click here

India is heavily depending on the import of raw materials and Oil for its industrial development. In the decreasing rupee scenario, the outgo of money will be much higher. This would affect the expenses for the companies who imports raw materials for their factory and all the Oil Marketing Companies (OMC) will incur heavy payment to import the Oil. Now you would have understood why the Petrol prices have been increase in the last fortnight. If you look into the news papers, the reason said by our finance minister was the depreciation of rupee value against dollar.

Major Factors Influencing the Currency Value

In the above section, I have explained in the simple words to make a common man understand the currency fluctuations. This section writes down few economic conditions when the currency value will be under pressure. The following are the three major factors influencing the changes in the currency values. There are many other factors too, but we are not talking about all the factors in this section.

·         Inflation

o    As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies.

·         Interest Rates

o    A higher interest rates offer good returns compare to other countries. It will result in the foreign capital come into the country. Lower interest rates decrease the currency value. Note that interest rates have the close relation with interest rates. The currency value would not be affected only based on the interest; it is impacted based on the other conditions like inflation or economic situation.

·         Current Account Deficits

o    Basically current account of a country presents the status on the trade of a country between other trading partners. If there is any deficit in the current account that means country is doing more trading outside the country then its actual earning inside the country. This situation is not good for a country because the country needs to buy more foreign currency to fulfill its need inside the country. A country needs to manage its deficit within control, otherwise it will lead to a economic problem. More demand for the foreign currency would reduce the value of that country’s currency.

Impact of INR vs USD

In the last two weeks Indian rupee has depreciated about 7% against the USA dollar value. It is expected that it would continue the slide as many macro economic factors not in favor of Indian economy. The following are the factors which would slide down the rupee value.

·         Foreign Funds Outflow

o    It is the major concern of Indian economy now. Because of the global uncertainty and various economy crisis like Europe sovereign debt problem, US economic slowdown, etc leads to search for the safe heaven among the investors. They are quickly pulling out the money from Indian market and investing in any other safe investments like Gold or US bonds.

·         Government Deficit is High

o    The government finances are in a bad shape and the combined central and state government deficit has stubbornly stayed around 10 per cent of GDP. It is high deficit and investors lost faith in the local economy.

·         Political Uncertainty and Corruption

o    This is one of the major factor for any country to stabilize the economy. In India, last one year we are seeing the series of corruptions and there is no good news from the ruling party (Congress) about the economic reforms and lot of agitation among the citizens including the veteran Gandhian Anna Hazare’s campaign of Fight for second freedom which took attention from global media. India needs political change to gain confidence among the investors.

Summary

I hope this article would have given an idea about the rupee depreciation and the reason why the currency is changed. But, there are hundreds of parameters to decide a currency value and politics also there to manipulate the own currency which China has done for a long time. The above are the very basic idea on currency value and how it is affected. If you have any thoughts, please post it in the comments section.

End of Kodak: A lesson to learn..

End of Eastman Kodak

Eastman Kodak Co. the unprofitable 131-year old camera maker, is weighing options including a bankruptcy filing because of concerns raised by possible buyers of its patent portfolio. It’s amazing to me that Eastman Kodak (EK) has lasted as long as it has. In the 1980s, Kodak was heading unstoppably for its end decades ago — but it took longer than anticipated. Kodak plunged 91 cents, or 54 percent, to 78 cents a share on September 30, in New York Stock Exchange composite trading, the biggest drop since at least 1974. Trading was halted four times by circuit breaker introduced following the May 6, 2010, crash to prevent losses in one security from spreading throughout the stock market.

When Kodak was founded in 1888, quality was its “fighting argument.” It gladly gave away cameras in exchange for getting people hooked on paying to have their photos developed  — yielding Kodak a nice annuity in the form of 80% of the market for the chemicals and paper used to develop and print those photos.

Inside Kodak, this was known as the “silver halide” strategy — named after the chemical compounds in its film. Kodak had a fantastic success formula that keyed off of international distribution, mass production to lower unit costs, R&D investment to introduce better products, and extensive advertising to make sure consumers knew about Kodak’s superior quality.

Unfortunately, competition came along and introduced ugly splotches all over this beautiful picture. Here are three examples:

·         Instant photography

 In 1948, a Massachusetts-based inventor, Edwin Land, offered consumers an instant camera that developed photos in 60 seconds – just in time for Thanksgiving. Instant photography threatened Kodak’s profits from chemicals and film. Kodak responded by introducing its own instant photography products. Polaroid sued — alleging that between 1976 and 1986 Kodak stole its technology – asking for $12 billion in damages. In 1990, Polaroid won a mere $909 million and ultimately filed for bankruptcy in October 2001.

Cut rate film from Japan

·          In the 1980s, Japan’s Fuji started to sell rolls of film at a price way below the one that Kodak had been accustomed to charging. Fuji’s willingness to cut prices was quite popular with the rapidly growing mass merchandisers like Wal-Mart (WMT) that preferred to deal with suppliers who were willing to sell high volumes at ever-lower prices. And Fuji helped make consumers aware of its value by sponsoring big events — such as the 1984 Los Angeles Olympics. By 1999, Fuji’s market share gains were so great that Kodak took a $1.2 billion charge along with 19,900 layoffs. Such layoffs persisted, for example in January 2009, Kodak took a $350 million charge to nuke 3,500 people on a 24% revenue plunge.

·         Digital photography

Digital photography offered consumers a better value but one that wiped out a decent way for Kodak to make money. After all, digital film — flash memory — was a low margin proposition even if you had the huge fabs needed to produce it. And even though Kodak was number two in digital cameras by 1999, it lost $60 on each one it sold. In one of many bids to replicate its Silver Halide business model in digital photography, Kodak offered a Photo CD film-based digital imaging product – but since it was priced at $500 per player and $20 per disc it did not attract many customers.

In January 1988, Kodak  acquired Sterling Drug for $5.1 billion.

Kodak thought this was a wise investment for two reasons: drugs had high margins and Kodak made chemicals. Unfortunately, those two facts were not sufficient to make this deal pay off for Kodak shareholders.

To do that, Kodak would have needed capabilities that it lacked — such as the ability to come up with new, valuable, patented drugs or to make generic drugs at a rock-bottom cost. It only took six years for Kodak to realize that Sterling Drug was not a good fit for Kodak and sell it off in pieces.

One hope for returning to a decent business model might have been producing high quality personal printers for those digital images. Selling inkjet cartridges and papers might have yielded a nice profit stream for Kodak. But regrettably for Kodak, many other competitors — most notably Hewlett Packard (HPQ), had gotten there first.

Since peaking in February 1999 at about $80 a share, Kodak shares have suffered a steady tumble that wiped out 99% of their value — to 78 cents a share as of Sept. 30.  At the end of June, Kodak’s liabilities exceeded its assets by $1.4 billion. It then owed $1.4 billion and had $957 million in cash, down $847 million from the end of 2010.

Its latest CEO (since 2005), former HP printer exec, Tony Perez, has been unable to revive Kodak. Last week, it pulled $160 million from its credit line and hired restructuring advisor, Jones Day on Friday even as Kodak denied that it was on the verge of filing for bankruptcy.

It’s taken decades for Kodak’s final picture to develop — but the corporate skull and crossbones it depicts is the result of too much success leading to a slow and painful inability to adapt to a changing competitive landscape. The end of Kodak marks the end of an era and gives a lesson to the world that no matter how big you are one has to fall if it fails to keep itself in line with the changing environment. To prosper one have to be innovative and flexible and corporate needs to formulate their strategies with much more accuracy leaving minimal chances of failure.

Understanding Foreign Exchange Market: The largest Financial Market

Foreign Exchange Market

Foreign exchange market or forex market is a worldwide decentralized over the counter financial market. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The trading starts at 10 am Monday as Australia Market opens and moves towards west as major financial centers such as Tokyo London, New York opens, finally the market closes on Friday at 5 pm in New York. The foreign exchange market determines the relative values of different currencies. The primary purpose of the foreign exchange is to assist international trade and investment, by allowing businesses to convert one currency to another currency, for example if I want to import goods from America then I have to make payment in terms of US dollars so I can exchange Indian rupees with US dollars through foreign exchange market. There is not a particular exchange for forex trading unlike equity and commodity exchanges but foreign exchange takes place through small financial institutions that are operating in different countries. Foreign exchange market is the largest and most liquid financial market with a daily turnover of $3.2 trillion. Foreign exchange trading takes place through spot, future, swap forward and options. Traders include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors

Major Currency Traders

All over the world there are various financial institutions that are involved in currency trading, majors being Deutsche Bank having 18.06%  share of total currency traded followed by UBS AG with 11.30%,Barclays Capital 11.08%, Citi 7.69% and JP Morgan having 6.35% of the currency traded. Trading in London accounted for 36.7% of the total, making London by far the most important global center for foreign exchange trading. In second and third places, respectively, trading in New York City accounted for 17.9%, and Tokyo accounted for 6.2%. More than 80% of the currency traded is for speculation purpose for earning profit from currency movement. US dollars is the most traded currency which accounts for 84.9% of daily currency traded followed by Euro 39.1%,Japnese  yen 19%, and pound sterling 12.9%.

Currency Trading

A currency is always traded in pairs, this is because when ever currency exchange takes place you are buying one currency and selling the other that you already hold. There are 6 major currency pairs which accounts for more than 95% of the total currency traded. The major currency pairs are:

EUR/USD: Euro and US dollar

GBP/USD: Pound Sterling and US dollar

USD/JYP:  US dollar and Japanese Yen

AUD/USD: Australian dollar and US dollar

USD/CAD: US dollar and Canadian dollar

USD/CHF: US dollar and Swiss currency.

All these major currency involves US dollars other currency which doesn’t involve US dollars are called minor currency.

Lots: In the past, spot forex was traded in specific amounts called lots. The standard size for a lot is 100,000 units. There is also a mini, micro, and nano lot sizes that are 10,000, 1,000, and 100 units respectively. Currencies are measured in pips, which is the smallest increment of that currency. To take advantage of these tiny increments, one need to trade large amounts of a particular currency in order to see any significant profit or loss.

Let's assume we will be using a 100,000 unit (standard) lot size. We will now recalculate some examples to see how it affects the pip value.

USD/JPY at an exchange rate of 119.80 (.01 / 119.80) x 100,000 = $8.34 per pip

USD/CHF at an exchange rate of 1.4555 (.0001 / 1.4555) x 100,000 = $6.87 per pip

In cases where the U.S. dollar is not quoted first, the formula is slightly different.

EUR/USD at an exchange rate of 1.1930 (.0001 / 1.1930) X 100,000 = 8.38 x 1.1930 = $9.99734 rounded up will be $10 per pip

GBP/USD at an exchange rate or 1.8040 (.0001 / 1.8040) x 100,000 = 5.54 x 1.8040 = 9.99416 rounded up will be $10 per pip.

. As the market moves, so will the pip value depending on what currency you are currently trading.

Leverage

 It a extremely difficult for small investor like us to trade such large amounts of money. In forex trading your broker acts as your bank. He leverage your account deposit in the ratio of 100:1 and sometimes even 200:1 varying from broker to broker. All he asks from you is that you give it $1,000 as a good faith deposit, which he will hold for you but not necessarily keep. This is how forex trading using leverage works. The amount of leverage you use will depend on your broker and what you feel comfortable with.

Typically the broker will require a trade deposit, also known as "account margin" or "initial margin." Once you have deposited your money you will then be able to trade. The broker will also specify how much they require per position (lot) traded.

For example, if the allowed leverage is 100:1 (or 1% of position required), and you wanted to trade a position worth $100,000, but you only have $5,000 in your account. No problem as your broker would set aside $1,000 as down payment, or the "margin," and let you "borrow" the rest. Of course, any losses or gains will be deducted or added to the remaining cash balance in your account.

The minimum security (margin) for each lot will vary from broker to broker. In the example above, the broker required a one percent margin. This means that for every $100,000 traded, the broker wants $1,000 as a deposit on the position.

PIP

A PIP stands for point in percentage. It is unit of measurement to express the smallest change in value between two currencies. A PIP is denoted by the 4 digit to the right of decimal in a currency pair however in pair involving Japanese Yen a PIP denotes 2 digit to the right of decimal. Every movement in pip in a currency pair involving US dollar  in a position of $100000 denotes $10 of profit or loss.

This is how a currency window looks like. Here the figure shows a currency pair of EURO and US dollar  The first currency in a pair is called base currency and the second is called counter currency. All the selling and buying of currency is done in term of the base currency. For example if are buying a currency pair involving EUR/USD then we are buying EURO and selling US dollar similarly if we are selling a currency pair EUR/USD we are selling EURO and buying US dollars. There is a difference in price that you pay to buy a currency and the price you get in selling the same currency this difference is known as spread this difference in price is kept by your broker as its profit.

Exchange Rate Determination

The exchange rates are determined completely on the principles of demand and supply, value of a currency having greater demand tends to appreciate and depreciates for currency with lesser demand. Besides this the market runs on fundamentals that is any national or international events having an impact on the economy will have a bearing on currency market. The market also runs on sentiments.

Analysis

On the whole a forex market gives us a good trading platform to earn a good return on our investment, since trading on forex market involves high leverage its can give a good return on the same time it can also wipe out your complete investment. Since it is difficult to analyze the changes  in forex market, factors that effects exchange rate, very few people tends to invest in foreign exchange market. Reports are published on daily basis analyzing the movement of market on a particular date so these reports can help you in investing, specially reports published by investments banks are more accurate the best being that of Goldman Sachs. Then you can also study the world economy and economic events in major developed nations as they have great impact on the exchange rate. Ex, right now due to the American debt crisis the demand for US dollars will be less thus the US dollar tends to depreciate in its value, similarly with European economy recovering the demand tends to increase. So if you properly analyze the market forex market can give you greater return than any other market.

                                                                                                

                                                                                                 

Financial Tsunami right ahead: The Fall of Greece

Financial Tsunami Coming right ahead

The Fall of Greece

After three years of struggle and receiving billions of euros as bailout package the Greek sovereign has worsened. Greece is at the edge of the biggest sovereign default and policy makers are worried about global shock waves of an insolvency by a government with 353 billion euros ($483 billion) of debt -- five times the size of Argentina’s $95 billion default in 2001.

There is a monstrously large amount of uncertainty and a massive range of possibilities. A macroeconomic disaster could be averted but only by aggressive policy action by central banks and governments.

After two international-bailout deals, three years of recession and budget-cutting votes that almost cost him his job, Greek Prime Minister George Papandreou says throwing in the towel now would be a “catastrophe.” Potential consequences of a national bankruptcy include the failure of the country’s banking system, an even deeper economic contraction and government collapse.

The fallout may echo the days following the 2008 implosion of Lehman Brothers Holdings Inc. when credit markets froze and the global economy sank into recession, this time with the prospect that the 17-nation euro zone splinters before reaching its teens. The International Monetary Fund, whose annual meetings start in Washington on September 24, reckons the debt crisis has generated as much as 300 billion euros in credit risk for European banks.

Default Risk

Greek two-year yields surged above 70 percent and credit-insurance prices on Greece indicate the chance of default at more than 90 percent. Investors can expect losses on Greek debt of as much as 100 percent.

People, justifiably, think the crisis is what we’re living now: cuts in wages, pensions and incomes, fewer prospects for the young. Unfortunately this isn’t the crisis. This is an attempt, a difficult attempt, to protect Greek and avert a crisis. Because the crisis in Argentina: the complete collapse of the economy, institutions, the social fabric and the productive base of the country.

Even if Greece receives its next aid payment, due next month, default beckons in December when 5.23 billion euros of bonds mature.

 Too Late

It’s too late for Greece, Howard Davies, The Greek situation is tumbling out of hand and Greece will not be able to avoid a substantial default. The introduction of the euro and global financial connections mean previous Greek defaults in the 19th and 20th century, most recently in 1932, don’t provide a decent precedent for a failure to satisfy lenders now.

Contagion will be violent as the price of the two-year Greek note tumbles below 30 cents per euro. The European Central Bank would be the first responders through purchases of government debt.

Greek Banks

The country’s banks, of which National Bank of Greece SA (ETE) is the largest, would be the next dominoes. They hold most of the 137 billion euros of Greek government bonds in domestic hands, a third of the total and three times their level of capital and reserves, says JPMorgan Chase. As those bonds are written down and equity wiped out, banks would lose the collateral needed to borrow from the ECB and suffer a rush of withdrawals that likely triggers nationalizations. No banking system in the world would survive such a bank run.

A hollowed-out banking sector wouldn’t be the only danger to an economy that the IMF says will contract for a fourth year in 2012. Greece will shrink 5 percent this year and 2 percent next year, reversing a forecast of a return to growth in 2012. Unemployment is set to rise to 16.5 percent this year, and to 18.5 percent next year, the highest in the European Union after Spain and dry kindling for potential social unrest. Even after saving 14 billion euros in debt repayments, much depends on what deal Greece could strike with its creditors.

 Large Haircuts

The losses from Greece-related exposures in isolation look manageable, even in a disorderly default scenario with large haircuts, though the ECB would probably require fresh capital from euro-area governments. A debt exchange that was part of the second Greek bailout approved by European leaders in July would impose losses of as little as 5 percent on bondholders. The risk is that the rot spreads beyond Greece as investors begin dumping the debt of other cash-strapped European nations. Portugal and Ireland have already been bailed out, while speculators have also tested Italy and Spain. Italy, the world’s eighth-largest economy, has a debt of almost 1.6 trillion euros, while Spain, the 12th biggest economy, owes 656 billion euros.

Grand Solution

The possible ripple effects explain why policy makers won’t let Greece default. Policy makers would only allow a Greek default if they think they can contain the fallout, which is a dangerous presumption. If Greece, Ireland, Portugal and Spain all impose haircuts, European banks could lose as much as $543 billion with those in Germany and France suffering the most.

Even those figures don’t tell the full story because they omit indirect exposure via derivatives such as credit-default swaps. U.K. and U.S. banks hold such insurance on Greek debt totaling 25 billion euros and 3.7 billion euros respectively. Extend that metric to the whole European periphery and U.S. banks have a 193 billion euro exposure.

Even Worse

Such linkages threaten an “even worse crisis” than the folding of Lehman Brothers, The amount of outstanding debt is more than with Lehman and we don’t know the amount of derivative exposure.

Governments must create a fund to inject capital into banks as the U.S. did with its $700 billion Troubled Asset Relief Program.

If banks fail, or if they fear big losses, they will stop lending. As things stand today, a credit crunch will corset euroland and a depression will ensue when Greece fails and takes out euroland’s banking system.

G-20 Signals

Signaling efforts to contain the crisis, European officials including French Finance Minister Francois Baroin yesterday said they may be willing to use leverage to boost the firepower of their 440 billion-euro bailout fund. Group of 20 finance chiefs said after talks in Washington late yesterday that European authorities are willing to “maximize” the fund’s impact by the time the group next meets Oct. 14-15.

The ECB may also intensify its own attempts to support growth and ease financial market tensions as early as next month. Potential measures include the reintroduction of 12-month loans to banks. A disorderly Greek default with spillover into Spain and Italy could mean the euro-area contracts 1.3 percent in 2012, using the Lehman Brothers episode as a benchmark.

Rebounds

After shrinking 10.9 percent in 2002 following its decision to default and devalue, Argentina’s economy grew eight years straight, exceeding 8 percent in every year aside from 2008 and 2009. Russia was growing in double digit just two years after defaulting on $40 billion of local debt in 1998.

In contrast, facing only hard choices, EU officials have taken half-measures in the hope that the situation would somehow turn around. What they have done so far is a patchwork approach, Now things are much worse. It’s becoming more expensive not only in economic terms but also in social terms for Greek citizens because now there will be redundancies, now there will be more taxes there will be less jobs and things will get worse.

If Greek defaults the contagion will soon spread to other Euro zone countries and the systemic risk will be beyond measures.  It’s certain that Greek has to default and it will default soon. If central banks and government fail to manage the ripple effect it would be impossible to survive the financial tsunami coming ahead. 

Rupee posts biggest weekly fall in 15 years

RBI Intervenes the Forex Market by selling Dollars

The rupee posted its biggest weekly fall in more than 15 years on Friday on heightened risk aversion amid the possibility of a recession in the developed world, even as it rebounded from a 28-month low on suspected intervention by the central bank.

Traders said the rupee will not be able to stay strong as growing concern about the impact of a possible Greek default on the banking sector will negate any move by India's central bank to support the unit.

"Rupee's loss is more than what is warranted when compared with gains in the dollar index. But we could see rupee hit 50.50 if the index touches the level of 80.

The Reserve Bank of India has not intervened in a big way in the currency markets, unlike most of its emerging Asian peers, because it can ill-afford to expend a limited and fragile holding of foreign exchange reserves.

That reluctance to intervene is just one of the factors that sets the RBI apart. It also is currently the most hawkish in the region, waging an expensive and tough war against inflation, while most of the world frets about slowing U.S. growth and a European debt crisis. A persistent current account deficit and realization that an uncertain global environment is bound to keep markets volatile are reasons the RBI is loath to intervene in a big way, spending its small pool of dollar reserves. While many Asian central banks including South Korea, Indonesia and Philippines have been spotted selling dollars to protect their currencies, the RBI has put up only a token show, with some minor intervention in recent weeks.

India's partially convertible rupee has been the worst performer among major Asian currencies -- so far in 2011, losing nearly 12 percent of its value since touching its 2011 high of 43.855 against the dollar on July 27. Intervention depends upon the pace of volatility. But the threshold for volatility also changes with the situation. Look at how the euro has been behaving, how gold, U.S. Treasuries have been moving. If all asset classes are so volatile, then the tolerance level will also rise.

The rupee has weakened nearly 7.2 percent against the dollar since late August, on heightened concerns over European sovereign debt and a likely Greece default. The euro has fallen on most days since Aug. 29, 7.3 percent down in the period and touched a seven-month low of $1.3499 on Sept. 12. In the same period, the key Asian currencies -- Korean won, Indonesian rupiah, Philippine peso have fallen between 1 percent and 10 percent.

UNDERVALUED

The RBI's modest approach would be understandable if they were keeping the rupee stable in trade-weighted terms, but that is not the case. The rupee has been increasingly undervalued in nominal trade-weighted terms.

However, this approach is not new. Its forex policy has by definition been hands off. Asia's third largest economy has reserves that are merely a tenth of the size of mighty neighbour China's. Because India runs a trade deficit, the reserves also comprise a pool of borrowed money that can dwindle quickly should foreigners pull short-term investments away from the country.

Still, many traders and economists are now questioning the wisdom of sticking to that practice amid high inflation, a large trade deficit and heightened uncertainty across currency markets. Downside pressure remains strong, and one-off intervention may not be enough in an environment of growing contagion risks. This begs the question of whether an increase in the frequency and magnitude of RBI intervention is likely.

The RBI was last a net seller of dollars in April 2009, when the Lehman crisis weakened the rupee, and any intervention since then has always been aimed at checking a rise in the local unit. But the biggest impediment to dollar sales is the country's current account deficit, a stark contrast with its Asian peers such as Indonesia, South Korea and Taiwan, all of whom are running current account surpluses.

There is an asymmetry when a central bank buys dollars to intervene and when it sells dollars to intervene. When you are selling dollars, you are losing the country's FX reserve, which is not a very comfortable thought given that we are a current account deficit country.

In the face of foreign fund outflows and India's trade deficit, the RBI's absence from the FX market has only fuelled investor pessimism towards the rupee. India's current account deficit in January-March narrowed to $5.4 billion from $12.8 billion deficit a year earlier, but the global slowdown could hurt exports, widening the deficit again. A wider current account deficit would put pressure on the country's ability to buy oil which is by far the largest component in India's import bill.

INFLATION AND INTERVENTION

Though the RBI maintains that it will never use the foreign exchange rate to contain inflation, selling dollars to arrest the rupee's current sharp drop has the added attraction of helping to ease imported inflation.

India's big state oil companies last week raised the price of petrol by nearly 5 percent.

"Yes, the petrol prices were raised because of the rupee depreciation and not due to any rise in global oil prices and that will have an impact on inflation". But any impact on inflation due to intervention will be incidental and not our objective.

India's inflation has stayed over 9 percent for the last four months and persistently above the central bank's comfort zone of 4.0-4.5 percent despite the RBI's aggressive 18-month rate tightening cycle. It is a sentiment spiral that started in August and I don't think the rupee will turn around unless there is some positive development globally.