Thursday 15 December 2011

News Hour- Why rupee falls to record lows against dollar

MUMBAI: India's central bank is being forced to forsake the rupee at record lows not merely by a shortage of ammunition to defend the currency but also by a compulsion to relieve stresses in the local debt market.

The Reserve Bank of India's hands-off approach is a factor that has pushed its tumbling currency to new lows each week. 

Its options are limited. Only about 6 percent of its $314 billion reserves are freely usable to intervene in currency markets. Even if it intervenes, that dollar-selling could take rupees out of an already tight and stretched banking system. 

Yet intervene it must, else a plunging currency will not only push the near-double-digit inflation even higher but also set off a negative spiral of capital outflows that will end in a severe balance-of-payments crisis. 

Trading at a record low of 53.64 per dollar, the rupee is close to the 55-level that market participants regard as a line in the sand. That is the level at which a creeping sense of anxiety over the balance of payments could give way to panic and distress. 

Analysts suspect the RBI is buying time. It can conserve FX reserves by waiting, and then step in with a combination of rupee-buying intervention and repos or other open market operations (OMOs) to replace the rupees it is soaking up. 

"The RBI's capability of intervening in the FX market has been severely hampered by the tight liquidity conditions in the money market," said Abheek Barua, chief economist at HDFC Bank. "This is now proving to be a problem with the rupee hitting record lows. To ease the liquidity cash crunch, it may start boosting the size of its OMOs as it will give it some much-needed headroom to intervene on the rupee." 

That is where intervention policy gets tricky. India's central bank has been providing increasing amounts of cash to its banking system. But it is doing so in phases to put a lid on surging bond yields and smooth a massive government borrowing. 

With annual inflation still running at above 9 percent and barely weeks after it raised rates for a 13th time, the central bank has to be careful how much cash it pumps in. 

"The question is, does the RBI want to signal that it's prepared to ease?" said Suresh Kumar Ramanathan, head of strategy at CIMB in Kuala Lumpur. "I do agree that intervention which is sterlised does not do any good in limiting this rupee weakness," he said. The RBI ought to be signalling a willingness to ease policy if it complemented its rupee defence with open market operations, he said. 

BEHIND THE CURVE 
The rupee has dropped 19 percent against the dollar since July, as much as it did during the worst of the Lehman crisis. The RBI's presence in the market has been sporadic and fleeting, giving analysts the impression it is prepared to risk being behind the curve.
(Source- http://economictimes.indiatimes.com

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