This Article is From Jun 26, 2013

Why RBI has failed to defend the Indian rupee

Why RBI has failed to defend the Indian rupee

The Indian rupee fell below the psychological mark of 60 on Wednesday, breaching the previously record low of 59.98 hit last week. The slump came despite reports of intervention by the Reserve Bank of India to shore up the Indian currency.

The rupee is the worst performing currency in Asia and the second worst in emerging markets after South African Rand.

Analysts told NDTV that the RBI does not have the fire power to defend the rupee.

The RBI is seen lacking fire power because it does not have reserves and there is "short rupee" in the system, Moses Harding of IndusInd Bank told NDTV Profit last week.

Short selling is the practice of selling financial instruments that are not currently owned, with the intention of subsequently repurchasing them at a lower price.

The central bank has foreign exchange reserves of $290 billion, only enough to cover imports for seven months according to Reuters data.

It is difficult to defend the currency against the market, Mr Harding said.

"Meeting the gush of demand from both domestic and offshore markets is difficult through supplies. It's like giving cheap dollars and bringing more demand," he added.

Mr Harding said it's important to support the sentiments around the rupee.

"The RBI should remove importers fear and exporters greed. Importers fear further depreciation in the rupee, so they are buying their long term payables and already corporates have shifted their loan exposure from rupee to dollar," Mr Harding said.

Exporters have sold their 60-75 per cent of their receivables and are holding back their remaining 25 per cent. This has to be addressed.

Outlining the reasons behind the free fall in the rupee, Mr Harding told NDTV that there are three dynamics at play.

1) India's huge current account deficit is being funded by foreign institutional investors (FIIs), who are retreating from Indian debt market post the sharp squeeze in the differential between the U.S. and India bond yields, which was at 1.5 per cent in the last 9-12 months.

2) Most importers and exporters took rupee stability for granted. So, importers are largely uncovered and exporters are mostly covered.

3) The Federal Open Market Committee (FOMC) is watching growth and employment on the one side for extending of quantitative easing (QE) and on the other hand watching the impact of QE on inflation. Now that they have got comfort on growth and employment, it makes sense for them to taper QE. What the markets expected was the QE to extend to 2015-16 but it has been cut short to mid-2014. This has led to huge selloff in asset markets.

The RBI is in a catch 22 situation, he added.

RBI is looking at retail inflation, where the government has to play a role through supply side absorption, which is not happening. The RBI has pulled the balance of payment (exports minus imports) on its radar, and the trend for BOP in absence of long term FDI flows and high dependents on FII flows is going to be negative, Mr Harding said.

So, the RBI has no option but to defer rate cuts beyond July to October or December till fresh cues emerge. Also, it cannot allow the 10-year yield to drop as U.S. yields inch up because that will trigger a FII pullout.

RBI supplying dollar will not be a sustainable solution, Mr Harding said. Markets need to hear quickly from the government about the FDI hike limit. It is important to reverse the sentiment and confidence of the stakeholders. If the government and RBI can come together, it will be important, Mr Harding added.

1) The government should open long term investment flows through FDI.

2) The RBI should engage other central banks to get dollar funding support to provide confidence.

3) NRI bonds are an instant solution as they would send a signal to markets that the RBI has another $5-10 billion to defend the rupee.