Sam Nagarajan and Anoop Agrawal, Bloomberg
The Indian rupee’s gain to an eight-year high suggests the central bank is allowing the market to set the exchange rate on speculation it favours a stronger currency to tackle inflation.
Volatility on one-month rupee options rose to the highest in three months on 28 March as traders bought protection on a further advance in the currency. Volatility eased as the rupee dropped 1.7% against the dollar, the biggest decline in 11 years, closing trading still near the strongest in 31 months.
“The central bank is looking at the rupee as a second instrument to rein in inflation, and that is why it is accepting the volatility,” said Prabal Banerji, chief financial officer at Hinduja Group in Mumbai, which has businesses in banking, automobiles and entertainment.
The rupee, which advanced 3.6% between 5 March and 28 March, is headed for the biggest monthly gain since October 2006, according to data compiled by Bloomberg. The currency is also set for a third winning quarter as Asia’s fourth-largest economy grows at a record pace.
India’s currency reached 43.025 to the dollar on 28 March, the highest since June 1999, as banks bought the rupee to replenish funds after an outflow estimated at Rs400 billion for quarter-end tax payments. The move was exacerbated on speculation some banks took advantage of overnight interest rates of as much as 70 percent to lend funds to banks short of rupees.The currency subsequently slumped yesterday as banks bought dollars as cash returned to the banking system.
“It appears the central bank has abandoned its rupee policy,” said Munish Saigal, director of foreign-exchange operations at Gurgaon-based Ranbaxy Laboratories Ltd., India’s biggest drugmaker. “Their prime concern is inflation and they aren’t very worried about the rupee’s valuation at the moment.”The currency is unlikely to weaken beyond 44, Saigal said.
One-month options on the rupee rose as high as 5.35 two days ago before slipping to 4.95 yesterday, suggesting traders and investors don’t see the currency making new highs.
Central bank policy makers raised the overnight lending rate between banks eight times since October 2004, tightened money supply by selling bonds and telling banks to set aside more cash to cover deposits, measures that failed to tame inflation.
A Bloomberg News survey shows wholesale price inflation may have accelerated to 6.5% in the week ended 17 March, near the highest in more than two years, a government report may show today. The Reserve Bank of India on 31 January said it will pursue the “medium-term goal” of inflation capped at 5%.
A stronger rupee helps lower the cost of imports such as crude oil and tempers energy prices that account for 14% of the wholesale price index.
“Despite the inflation bugbear, we’d have expected the central bank to have managed liquidity in a smoother fashion, acting more aggressively to alleviate shortages,” wrote Mumbai- based Tushar Poddar and Hong Kong-based Mark Tan, analysts at Goldman Sachs Group Inc., in a research note last week.The rupee may weaken to 44.15 a dollar in three months, they wrote.
The Reserve Bank of India has often said it acts in the market “to smooth volatility” in the currency without targeting a specific exchange rate.The central bank’s currency policy is aimed at helping boost exports and narrow the trade deficit, and is unlikely to change, said N.S. Paramsivam, head of treasury at Mumbai-based Essar Group, which has businesses in steel, shipping, oil and telecommunications.
The recent inaction by the central bank is “nothing but a tactical retreat and shouldn’t be construed otherwise,” he said. Policymakers “are for a stable currency to help exporters.”The currency will weaken as inflation slows next month, he said, without giving a forecast.
The central bank stepped up dollar purchases in February to prevent a stronger currency from hurting exporters. Shipments from the country slowed to 5.5% in January, the least in more than three years, according to the Ministry of Commerce & Industry.
In the four weeks through 2 March, the nation’s foreign- exchange reserves rose a record $14.6 billion, suggesting the central bank increased dollar purchases. It bought $7.8 billion in the three months through January.