Mumbai: The rupee had its biggest single-day fall since 1996 on Wednesday on heavy dollar demand from state-run banks and continued flight of investors from the stock market.
The currency dropped 2.4% to close at 49.31 against the dollar.
The rupee, which had closed at 48.12 on Tuesday, had rebounded after falling to an all-time low of 50.29 a dollar on 27 October. It strengthened to 47.20 a dollar on 5 November as foreign institutional investors (FIIs) turned net buyers of Indian equity.
But the currency, which has now fallen 20% against the dollar this year, started losing ground as FIIs resumed selling again, and in the absence of active intervention by the Reserve Bank of India (RBI), dealers said.
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RBI buys or sells dollars in the market to influence the exchange rate. Aggressive dollar selling by RBI to strengthen the rupee caused the country’s foreign exchange reserves to fall to about $253 billion in October from $316 billion in May.
Foreign fund inflows have stopped because of the global financial turmoil that has caused overseas investors to take their money out of emerging markets. The dollar’s relative strength against other currencies has also weakened the rupee.
The Bombay Stock Exchange’s benchmark Sensex index fell 3.1% on Wednesday on top of a 6.6% loss on Tuesday. FIIs have been net sellers of Indian stocks to the extent of about $12.7 billion (Rs61,976 crore) so far this year, after having been net buyers to the tune of $17.36 billion in 2007.
The dollar had depreciated against major currencies in 2007 as the credit crisis emerged. Investors globally withdrew money from stock markets in emerging economies and invested in the US treasury, labelled the safest asset class in the world.
This flight to safety, however, prompted the US dollar to strengthen as investors needed dollars to stay invested in the US treasury. Except for the Japanese yen, the dollar has strengthened against all major currencies worldwide in 2008.
Currency traders are groping for direction in the volatile market.
“If a customer comes and sells me $10 million, I would immediately sell it in the market. Earlier, I would have held it for a little while and wait(ed) for a better level, but not any more,” said a senior dealer with a large foreign bank, who did not want to be identified.
He also blamed RBI’s recent hands-off approach for the volatility. “Their stated policy and objective is to curb volatility. But in the bargain they are actually adding to the volatility by not intervening when the market expects them (to),” he said.
“Rupee can go anywhere now,” said the dealer, who didn’t want to be named because of company policy. “It can cross 50, it can...(reach) below 45 by December, it all depends how global development pans out.”
Another dealer from a foreign bank, who also spoke on condition of anonymity, said the volatility had left him without a sense of direction on the rupee.
“Suppose we give a price to our customer, by the time we go to cover the position, prices go up,” this dealer said.
The rupee’s fall is the outcome of both the global crisis and the cloudy outlook for the Indian economy, said Rugved Dhumale, a senior manager at foreign exchange consultancy Mecklai Financial and Commercial Services Ltd. Economic growth is slowing, partly because of the impact of the global financial crisis.
“The spectacular growth story of our economy has kind of hit a speed breaker,” said Dhumale. “The whole market is extremely uncertain about the outlook of the Indian economy,” he added. “Investors are keenly watching foreign capital flows, trade deficit, and how the import bill will come up now that the oil price has come down.”
Rupee liquidity could be one factor. Banks have been buying and selling the rupee the past few days irrespective of the prevailing rate, to tide over tight liquidity in the market, dealers said.
Arbitrage between non-deliverable futures overseas and the Indian forward market is also causing the rupee to depreciate.
Offshore forward contracts for one-month dollar shot up from 48.72 on Tuesday to 50.03 a dollar on Wednesday, according to Bloomberg.
“If you ask me why the rupee is depreciating, I would say it’s demand and supply and arbitrage,” said R.A. Sankara Narayanan, chief dealer at state-owned Bank of India. “It is mirroring either stock market or NDF (non-deliverable forward).”
The rupee will strengthen back to 46 a dollar after touching 50 in the interim, he said.
Although the difference between the one-month domestic forward and the offshore forward is only 10 paise, the difference between the one-year forward is Rs2.50, and the six-month difference is Rs1.50.
This has lead to huge arbitrage between the two markets in these longer tenure forwards. The effect, according to dealers, is spilling over in the local currency market. Indian forward contracts overseas are settled in dollars.
Ashwin Ramarathinam and Bloomberg contributed to this story.