The rupee may fall this week on speculation that the central bank will sell the currency to help banks meet an increase in the cash amount they must set aside to cover deposits.
The cash reserve ratio for banks will be raised to 6.5% from 6% in two stages starting 14 April, the Reserve Bank of India (RBI) said after markets closed on 30 March, a measure that will drain Rs15,500 crore ($3.6 billion) from the banking system. RBI lifted the repurchase rate, the rate at which it lends overnight to banks, to 7.75% from 7.5%.
“The increase in cash reserve will give a cushion to the central bank to buy dollars,” said Mohan Shenoi, treasurer at Kotak Mahindra Bank in Mumbai. “That should pressure the rupee downward this week. Banks will look to sell dollars more aggressively, which the central bank may absorb.”
The rupee rose 2.7% in the fiscal year through 30 March to 43.49 against the dollar, according to data compiled by Bloomberg. It may decline to 43.75 this week, Shenoi said.
Governor Y.V. Reddy has raised borrowing costs six times in 14 months to curb inflation, which has stayed a percentage point above the bank’s highest estimate.
The rupee rallied to an eight-year high on 28 March on a cash shortage in the banking system, then had its biggest drop in 11 years the day after. “There are concerns about inflationary pressures being reinforced by ample liquidity driven by excess capital flows,” Reddy said in Cernobbio, Italy, while the central bank issued a statement in Mumbai announcing the measures.
“The currency appreciation or depreciation could, at times, be steep and sudden, resulting in disruption in the real sector and, therefore, there is a need for containing excess volatility in foreign-exchange markets.”
Inflows of investment from abroad, attracted by India’s economic growth, are also helping the rupee gain. Direct investment from abroad may double to $12 billion in the year ended 31 March, exceeding equity purchases by overseas investors for the first time, industry and commerce minister Kamal Nath said in February.
The monetary authority raised the cash reserve ratio in December and February by half a percentage point each time, draining Rs27,500 crore in total.
That, along with tax payments of about Rs40,000 crore in March, forced banks to sell dollars for their lending needs in order to avoid borrowing from the overnight money market, where rates reached the strongest in a decade last week. This sent the rupee to its eight-year high last week.
Bankers said Reddy has abandoned RBI’s policy of keeping a firm check on volatility in the rupee-dollar market and allowed the currency to appreciate.