Knowledge Articles-The falling Rupee– RBI’s stance

Measures taken by the RBI to check the falling Rupee

After several months of continuous slide, the rupee finally recovered a part of its losses yesterday and in early morning trade today. The recovery came after it touched a fresh low of 54.3 to the dollar yesterday, which propelled the Government and the RBI to take strict steps to check the fall. The central bank has been maintaining so far that it cannot aggressively intervene in the currency market due to limited reserves and also as a part of its foreign exchange policy. Yesterday, it came out with a slew of measures to reduce speculative elements in markets to reduce the volatility. Some of the measures taken were as follows:

•  The RBI imposed restrictions on forward trading to check the slide in the rupee. RBI said that the companies cannot enter into multiple forward contracts to cover a single overseas transaction. They will no longer be allowed to re-book forward contracts after cancelling them. Also, all the contracts should be on a delivery basis. This means parties involved in such contracts must receive the currencies. The new rule applies to the domestic as well as foreign investors and takes effect immediately.

•  The RBI revised the exposure limits of currency dealers in spot and forwards market with immediate effect making it difficult for market players to keep speculative positions open for a long time. For banks also, it has reduced the overnight open position limit, or the bank’s unhedged exposure in currency market. The new limit for such exposure will now be determined by the central bank and not the boards of commercial banks. As a result of these measures, neither firms nor banks will be able to punt on the rupee and take advantage of volatility in the foreign currency market.

•  RBI also said that the eligibility of the exporters and importers to claim the benefit of “probable exposures based on past performance” has been reduced to 25% of the average of import/export turnover in the past three years. In case of importers who have already utilized in excess of the revised/reduced limit, no further bookings may be allowed under this facility. Also, all the forward contracts booked under this facility by both exporters and importers will be on fully deliverable basis. The move was aimed to ensure that the exporters or importers, when they enter into currency forward market, should enter only to hedge their exposures and once they take a view on currency, they cannot change it.

•  The RBI has also sold dollars aggressively to curb the rupee's fall.

Earlier in the year, the RBI had increased the ceiling on interest rates on NRI deposits in November. It had also removed the $100 million cap on net foreign exchange supply arising out of rupee swap transactions that banks undertake on behalf of customers. RBI’s measures are aimed at pushing speculators out of the currency markets and leave only investors, who would need to hedge their exposure.

Highlights of the credit policy

Faced by the challenges of rapidly depreciating rupee against the greenback and sagging economy, the Reserve Bank of India, refrained from raising interest rates for the first time in eight meetings and kept key rates and ratios unchanged in today’s mid-quarter monetary policy review meet. The central bank had increased its repurchase rate by 375 basis points in 13 moves since mid-March 2010, the fastest round of increases since the central bank was established in 1935. The pause came after the inflation slowed to a one-year low, the economy expanded at the weakest pace in more than two years and the industrial output fell for the first time in 28 months, tilting the balance from inflation towards growth. The RBI, however refrained from a reduction in rates for now as inflation is still quite elevated. Key highlights of the policy include:

• The Repo and Reverse Repo rates were kept unchanged at 8.5% and 7.5% respectively, to arrest the rising inflation and slowdown in Asia's third largest economy.

•  The Cash Reserve Ratio, which is the amount of cash the banks have to maintain with the central bank, was kept unchanged at 6 per cent, despite market speculation that it might cut the ratio in order to bolster market liquidity. Bank rate was also maintained at 6%.

• The bank said that it could not speculate when it would start cutting rates, and that the Open market operations (OMOs) would be conducted as and when required.

• It also highlighted that the worsening global economic outlook threatens emerging market. The economic growth was seen moderating and the downside risk to growth had increased.

• The inflation projection for March 2012 was retained at 7 per cent.

The RBI said that the weakening of sentiments makes it necessary to shift some of its focus back to near term issues. The growth rate has fallen sub 7% levels. However, the Rupee depreciation has also started adding pressure to inflation.
Although we did not see any aggressive actions from the RBI in its current policy review, we do expect some stringent actions in the upcoming policy announcements if the depreciation in rupee goes unabated despite the measures taken yesterday.