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.
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