'RBI must enter forex market to support Rupee, curb inflation'

Nov 18 2012, 18:53 IST
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The rupee will remain volatile till RBI recoups the forex reserves of USD 65 billion: Sen Gupta. (Reuters) The rupee will remain volatile till RBI recoups the forex reserves of USD 65 billion: Sen Gupta. (Reuters)
SummaryThe rupee will remain volatile till RBI recoups the forex reserves of USD 65 billion: Sen Gupta

RBI to accumulate forex and the forex market to buy the rupee.

"The RBI should then achieve its twin objectives of stabilising the forex market and reducing 'imported' inflation pressures. The forex market could easily make 5-10 percent and its gains would be relatively better protected if RBI is in a stronger position to protect the rupee from contagion," the report said.

The report said "not only has RBI not been able to buy forex, but it has also actually had to sell USD14 billion forwards.

"Barring occasional bouts of optimism, most of which have ended in grief, the forex market has sold the rupee for the large part since end-2011. If this continues, the local unit would become a story of lower tops and deeper bottoms," it warned.

Stating that higher forex reserves can drive the rupee again in the 1990s fashion it said, "With the import cover down to seven months, last witnessed in 1996, RBI will again have to generate investor confidence by recouping forex reserves."

In the 1990s, the RBI used to build forex reserves as insurance cover to protect the balance of payments from a 1991-type crisis. The then governor Bimal Jalan and deputy governor Y V Reddy used to buy as much forex as possible during capital inflows and sell as little as they could during capital outflows.

They also floated the 5-year Resurgent India Bonds in 1998 after the Asian crisis and India Millennium Deposits in 2001 to raise USD 5 billion each, after the dotcom bust.

As these measures built up forex reserves, improved investor confidence led to capital inflows and by extension, appreciation. In fact the rising forex reserves drove the rupee during the FY98-2004 period.

Noting that RBI's exchange rate policy shifted gears by the mid-2000s, the report said surplus capital inflows began to push up the rupee. As a result, the RBI had to buy forex during the up-cycle of 2004-07 to stop undue appreciation the report noted.

However, it notes that the situation changed dramatically after the Lehman crisis. Capital outflows began to pull down the rupee. In response, RBI had to sell dollars to prevent a run on the rupee in 2008 and end-2011.

But it also notes that RBI attempts propping up the rupee between the second half of of 2009 and first half of 2011 against imported inflation at the cost of buying forex, pulled down the import cover down to 1990s levels.

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