It’s not just firms and investors who are panicking at the rupee’s fall into a bottomless pit. Policymakers are trapped, too, leading to repeated assertions that the central bank, the Reserve Bank of India (RBI), will not intervene except to smoothen excess volatility and will not sell “aggressively”, adding for good measure that its “ability to intervene in the forex market is limited”.
This has made the rupee a sure-bet risky asset, firming expectations that the currency will fall continuously ahead. The remarks are also bringing forward the annual, year-end ritual of profit-booking by many investors—that is, those who haven’t already repatriated funds to meet liquidity squeezes in their home markets. They are hurrying to sell off now instead of in December. With the value of their investments already eroded by the double blow of falling stock prices and a depreciating currency, which investor wants to risk losing some more?
There were reports of central bank intervention as the rupee dropped to 52 to the dollar on Monday. But then it seems that the intervention will not be aggressive, begging the question of why RBI need intervene at all. Data showed a feeble intervention of $845 million by RBI in September, less than 10% of the size of the trade deficit. This was when exchange rate changes deviated almost 4% from their mean in August and September vis-à-vis July movements. Smoothening excessive volatility is defying definition.
Subsequent events have unfolded disastrously, indicating this couldn’t have come at a worse time. The sustained depreciation of the currency is imparting a fresh impulse to inflation. The sharp rise in import costs will certainly impact domestic prices as producer firms—already facing margin pressures from high interest and wage costs—will be unable to absorb this shock themselves. A sizeable intervention earlier on in October would have been meaningful in moderating the steep fall and played a useful role from a macroeconomic perspective; it would be consistent with the price stabilization objective, besides reducing the weight upon the interest-rate tool.
And it’s not just global uncertainty as being argued by policymakers: from August 2011 until 21 November, the rupee’s fallen some 18%; in comparison, currencies such as the South Korean won, which is highly exposed to US-European Union trade, and the Singapore dollar have fallen half that value, whereas the Taiwanese dollar and Thai baht have weakened just an odd 5%. That tells us the extent of punch that weak fundamentals are adding to the currency’s weakness, besides external events.
By all accounts, the rupee saga is not yet over. First, foreign investors typically do not make fresh portfolio allocations at the end of the year. Two, economic fundamentals will continue to be weak; GDP (gross domestic product) growth data expected next week will surely show further slowdown. Last, the RBI might just be prevented from an explicitly pro-growth stance if currency depreciation triggers a fresh spurt of inflation; this wouldn’t go down too well with equity markets from where the currency derives its support.
Renu Kohli is a New Delhi-based macroeconomist and a former staff member of the International Monetary Fund and the Reserve Bank of India.
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