RBI must enter forex market to support rupee, curb inflation: BofA-ML

Leading US brokerage Bank of America-Merrill Lynch (BofA-ML) has called upon the Reserve Bank to enter the forex market and buy dollars to recoup the rupee and thus arrest the imported inflation, which is the main reason for the continued price spiral.

Stating that lending rate cuts and higher forex reserves hold keys to the market and growth recovery, a BoA-ML India report authored by its chief economist Indranil Sen Gupta said, "The rupee will remain volatile till RBI recoups the forex reserves of $65 billion, including the forwards which it had sold since the 2008 global credit crisis following the fall of Lehman Brothers."

On imported inflation, it said a 10 per cent fall in the rupee translates itself into a 100 bps rise in inflation.
Stating that non-intervention is the reason for the rupee fall, it noted that RBI is not buying forex to comfort
the market because it thinks that market may sell the rupee due to a forex shortage which will further fuel inflationary pressures.

The report notes that "in September-November 2011, the steep 13.4 per cent of the rupee depreciation was, after all, aggravated by payment of bunched up dues of about $5 billion to Iran for oil imports. A 10 per cent depreciation of the currency typically translates into 100 bps of inflation."

The rupee is the second worst performer among the BRICs currencies, after the Brazilian real, losing nearly 19 percent since September 2011, the report said.

Last Friday, the rupee hit a two-month low of 55.15 to the dollar. The life-time low of the local unit was in
mid-June when it had plunged to 57.15 to the greenback. In the year-to November 2, the RBI had sold over $21 billion to prop-up the rupee. Between August and December 2011, the rupee had lost 17 percent.

"We do not expect the forex market to get bullish on the rupee until the RBI has recouped forex reserves. After all, the country's import cover has halved to just about seven months -- the least since 1996 -- from 14 months in 2008.

"The RBI will need to buy USD 90 billion if it is to replenish the import cover to even nine months. Just as
importantly, the forex market will also fear that the rupee may see disproportionate losses in case the dollar shoots up," Sengupta said.

He further said to stabilise the rupee, "The best solution surely will be for RBI to accumulate forex and the
forex  market to buy the rupee.