The rupee has lost some 18% since January and at Friday’s lowest level (49.30 to a dollar), the deprecation was more than 20%. While RBI’s dollar buying added to the rupee liquidity in the financial system, for every dollar it sells now, an equivalent amount of rupees is sucked out of the system. In October alone, the market estimates that the central bank has sold at least $5 billion. The latest data shows that for the week ended 3 October, India’s foreign exchange reserve declined by $7.8 billion—the highest in a week in past two years—to $283.9 billion. Both dollar sale and revaluation of global currencies contributed to the fall in reserves.
Overall, India’s foreign exchange reserve has gone down by more than 10% or $32 billion since May, signalling RBI’s presence in the currency market as a seller.
RBI needs to supply dollar in the market as other sources are fast drying up. Foreign institutional investors or FIIs, the main drivers of Indian equity markets, have sold Indian stocks worth $10.18 billion this year, net of buying, after pumping in $17.36 billion in 2007. The volume of Indian firms’ overseas borrowing is also coming down sharply as money is becoming more expensive overseas following the global credit crisis. Finally, exporters, who earn dollars and sell them in the local market, too do not have too much of greenback in their kitty as most of them sold their dollar receivables in the forward market, apprehending further appreciation of the rupee. The trend has reversed and they have been caught off-guard.
The only source of dollar at this point is foreign direct investment (FDI) but that can take care of a very small part of the demand. On the other hand, importers are buying dollar aggressively as they fear rupee can depreciate further.
In the first five months of the fiscal year, between April and August, the trade deficit or the gap between the cost that India incurred for importing goods, including oil, and its earnings on exports is close to $51 billion and it has been rising every month.
For instance, in July the trade deficit was $10.79 billion and it rose to $13.94 billion in August. Even if the trade deficit remains at the August level, RBI needs to sell about $690 million daily in the foreign exchange market in the absence of any other supplier.
RBI’s dollar sale is only one of the causes of the liquidity crunch. Oil and fertilizer firms seem to be the biggest guzzler of bank credit, which has risen 24.8% year-on-year till 10 October.
Oil marketing firms need money to bridge the gap between the cost of importing oil and the price at which the product is sold in the domestic market. The government is supposed to take care of the deficit by issuing oil bonds to these firms. The deficit for the past year was some Rs14,000 crore and despite the 50% fall in international crude prices from its peak, this year’s deficit could be around Rs25,000 crore. Since the government has not issued oil bonds yet, the banking system is bearing the burden.
Similarly, banks have also been lending big money to fertilizer firms since government subsidy has not yet been released. This amount could be as much as Rs30,000 crore. The banking system has not yet been reimbursed by the government of the Rs66,477 crore farm loan waiver and debt relief that was completed in June.