Economy
No target or band set for rupee: Gokarn

RBI says its policy on intervention not only aims at quelling the excessive volatility, but also attempts to moderate speculative one-way downward movement of the rupee

 
Mumbai: Reserve Bank of India (RBI) will intervene in the forex market only to curb excessive volatility in exchange rate but stated there is no target set for rupee, deputy governor Subir Gokarn said, reports PTI.
 
"Our approach has been that the exchange rate of the rupee should be market determined and the Reserve Bank should be intervening only to manage excessive volatility... without targeting any particular level or band," Gokarn told an RBI-ADB conference on 'Managing capital flows'.
 
From a short-term perspective, the decision to intervene in order to avoid destabilisation of both exporting and import-competing producers needs to be viewed in the overall context of domestic conditions.
 
He further said the RBI policy has been articulated as broadly "non-interventionist", except when confronted with excessively volatile and lumpy or disruptive flows.
 
He also said the policy on intervention not only aims at quelling the excessive volatility, but also attempts to moderate speculative one-way downward movement of the rupee.
 
The rupee was the worst performer amongst the 25 leading global currencies last month losing over 4.2%.
 
Since September 2011, rupee has lost 19% and has been the second worst performer amongst the BRIC currencies year to date after the Brazilian real.
 
Today, however, the local unit gained 10 paise to end at 55.06 to the dollar against a two-month low it hit last Friday at 55.16. In late June this year, the rupee sunk to its life-time low of 57.15.
 
Talking about lessons learnt from volatile capital flows, Gokarn said the drivers of the currency volatility become more dominant if current account deficit is high.
 
Therefore, "addressing the domestic drivers of currency dynamics holds key to rupee stabilisation," he said.
 
On corporates concentrating on forex gains to boost profits, Gokarn said, companies should be concentrating more on their core business to generate returns rather than looking to generate profits from diversifying into trading in forex markets.
 
Incidentally, many companies and even banks reported good bottomlines in the second quarter which was partly attributable to gains made by them in forex market.
 
He also said banks are expected to show caution while offering forex derivatives to companies as firms enter into such transactions without fully understanding the downside implications of such deals.
 

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RBI must enter forex market to support rupee, curb inflation: BoA-ML

According to BofA-ML, the Indian rupee will remain volatile till RBI recoups the forex reserves of $65 billion, including the forwards which it had sold since the 2008 global credit crisis

 
Mumbai: Leading brokerage Bank of America- Merrill Lynch (BofA-ML) has said that the Reserve Bank of India (RBI) needs to intervene in the forex market to recoup the rupee and thus arrest the imported inflation, considered the main reason for spiralling prices, reports PTI.
 
Stating that lending rate cuts and higher forex reserves hold keys to the market and growth recovery, a BoA-ML India report, authored by its chief economist Indranil Sen Gupta, said: "The rupee will remain volatile till RBI recoups the forex reserves of $65 billion, including the forwards which it had sold since the 2008 global credit crisis following the fall of Lehman Brothers."
 
"We do not expect the forex market to get bullish on the rupee until the RBI has recouped forex reserves. After all, the country's import cover has halved to just about seven months -- the least since 1996....
 
"The RBI will need to buy $90 billion if it is to replenish the import cover to even nine months. Just as importantly, the forex market will also fear that the rupee may see disproportionate losses in case the dollar shoots up," Sengupta said.
 
The report also said that to stabilise the rupee "the best solution surely will be for RBI to accumulate forex and buy the rupee."
 
On imported inflation, it said a 10% fall in the rupee translates itself into a 100 bps rise in inflation.
 
Stating that non-intervention is the reason for the rupee fall, it noted that RBI is not buying forex to comfort the market because it thinks that market may sell the rupee due to a forex shortage which will further fuel inflationary pressures.
 
The report notes that "in September-November 2011, the steep 13.4% of the rupee depreciation was, after all, aggravated by payment of bunched up dues of about $5 billion to Iran for oil imports. A 10% depreciation of the currency typically translates into 100 bps of inflation." 
 
The rupee is the second worst performer among the BRICs currencies, after the Brazilian real, losing nearly 19% since September 2011, the report said.
 
Last Friday, the rupee hit a two-month low of 55.15 to the dollar. The life-time low of the local unit was in mid-June when it had plunged to 57.15 to the greenback. In the year-to 2nd November, the RBI had sold over $21 billion to prop-up the rupee. Between August and December 2011, the rupee had lost 17%.
 
"The RBI should then achieve its twin objectives of stabilising the forex market and reducing 'imported' inflation pressures. The forex market could easily make 5-10% and its gains would be relatively better protected if RBI is in a stronger position to protect the rupee from contagion," the report said.
 
The report said "not only has RBI not been able to buy forex, but it has also actually had to sell $14 billion forwards.
 
"Barring occasional bouts of optimism, most of which have ended in grief, the forex market has sold the rupee for the large part since end-2011. If this continues, the local unit would become a story of lower tops and deeper bottoms," it warned.
 
Stating that higher forex reserves can drive the rupee again in the 1990s fashion it said, "With the import cover down to seven months, last witnessed in 1996, RBI will again have to generate investor confidence by recouping forex reserves." 
 
In the 1990s, the RBI used to build forex reserves as insurance cover to protect the balance of payments from a 1991-type crisis. The then governor Bimal Jalan and deputy governor YV Reddy used to buy as much forex as possible during capital inflows and sell as little as they could during capital outflows.
 
They also floated the 5-year Resurgent India Bonds in 1998 after the Asian crisis and India Millennium Deposits in 2001 to raise $5 billion each, after the dotcom bust.
 
As these measures built up forex reserves, improved investor confidence led to capital inflows and by extension, appreciation. In fact the rising forex reserves drove the rupee during the FY98-2004 period.
 
Noting that RBI's exchange rate policy shifted gears by the mid-2000s, the report said surplus capital inflows began to push up the rupee. As a result, the RBI had to buy forex during the up-cycle of 2004-07 to stop undue appreciation the report noted.
 
However, it notes that the situation changed dramatically after the Lehman crisis. Capital outflows began to pull down the rupee. In response, RBI had to sell dollars to prevent a run on the rupee in 2008 and end-2011.
 
But it also notes that RBI attempts propping up the rupee between the second half of of 2009 and first half of 2011 against imported inflation at the cost of buying forex, pulled down the import cover down to 1990s levels.
 

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“India’s growth recovery to remain shallow”

India’s macro-economic data, just released, suggests that the economy is facing severe supply-side constraints, which is leading to the odd combination of weak domestic output, high and sticky inflation and a widening trade deficit, says Nomura

 
Economic data, released on Monday, show negative industrial output growth, high and sticky inflation and a record-high trade deficit, led by improving non-oil imports. The latter is not consistent with a slowing economy, says Nomura research in its Asia Insights. The brokerage believes that industrial output data may be exaggerating the growth slowdown, but power outages have also constrained production. Meanwhile, the higher trade deficit reflects weak exports, a seasonal rise in gold demand and also a genuine improvement in imports due to import substitution. Overall, the data suggest that the economy is facing severe supply-side constraints, making it imperative to ease bottlenecks. Until then, Nomura expects India’s growth recovery to remain shallow as the economy will be quick to hit a ceiling. Moreover, India’s external situation remains very worrying. Nomura sees upside risks to India’s current account deficit forecast (of 3.8% of GDP in FY13) with current trends suggesting that that the deficit could be as high as in FY12 (4.2% of GDP).
 
All in all, data suggests that the economy is facing severe supply-side constraints, which is leading to the odd combination of weak domestic output, high and sticky inflation and a widening trade deficit. This makes it all the more crucial to hasten the process of land/environmental clearance and speed up the setting up of the National Investment Board, says Nomura but is there enough of political will for it?
 
Nomura has highlighted that India’s current account deficit (CAD) should rise to around 4.9% of GDP in Q3 CY 2012. However, the October trade deficit data suggests no turnaround is yet in sight. With a worsening trade deficit and high and sticky inflation, the monetary policy cannot be eased very aggressively. Nomura continues to expect a 50 basis point (bp) repo rate cut in H1 2013, with policy rates likely to stay on hold after that.
 
India’s macro-economic data paints a puzzling picture. Industrial production (IP) growth contracted 0.4% y-o-y (year-on-year) in September (2.3% in August). However, CPI inflation remained sticky at 9.75% y-o-y in October (9.73% in September) and the trade deficit widened to an all-time high of  $21 billion in October from $18.1 billion in September due to weak exports (-1.6% y-o-y in October versus -10.8% in September) and stronger imports (7.4% versus 5.1%). The latter is not consistent with an economy that is slowing sharply. To understand this disconnect, Nomura makes the following five points:
 
Power outages disrupt output: The negative surprise in IP data largely owes to contraction in capital goods (-12.2% y-o-y in October versus -3.4% in September) and consumer durables output growth (-1.7% versus 0.6%). While firms usually build inventory pre-festival seasons in October/November, Nomura believes that power outages may have constrained production this year, resulting in firms drawing down on inventory to meet demand. In addition, consumer non-durables output growth moderated sharply (1.1% versus 5.8%) reflecting lower summer crop production.
 
Growth is bottoming out, not falling: Growth in the intermediate goods output, a precursor to final demand, remains positive and, on a three-month moving average (3mma) basis, IP growth rose 0.5% y-o-y in September from a trough of -0.7% in May. Excise tax collections are accelerating, up 17.5% y-o-y (3mma) in September from 0.3% in April. Import growth, excluding oil and gold, is also trending higher. Therefore, Nomura believes that the IP data may be overestimating the growth slowdown. More likely, Nomura believes that the industrial cycle is bottoming-out. Unlike the past, Nomura expects a longer period of consolidation in this cycle due to weak exports, lacklustre investments and moderating consumption demand.
 
Reasons behind higher trade deficit: While weak exports are partly responsible, higher oil prices are not. Nomura estimates that the oil trade deficit (exports minus imports) has widened only marginally to $9.9 billion in October from $9.5 billion in September, while the non-oil trade deficit has worsened to $11.1 billion from $8.6 billion. This is partly due to the pre-festival seasonal rise in gold imports—the trade deficit worsened by an average of $3.8 billion between September and October during the last three years. However, the trend in imports ex-gold is also clearly higher.
 
Reasons behind sticky CPI inflation: Food inflation has moderated marginally to 11.45% y-o-y in October from 11.75% in September. But within this aggregate, cereals and pulses prices are rising sharply, while fruit and vegetable prices have moderated. The government’s wheat procurement program has created an artificial scarcity in markets pushing up prices, while pulses prices have risen due to lower output. Meanwhile, core CPI (ex-food and fuel) has remained unchanged in the 8.3-8.4% y-o-y range for three months now.
 
Import substitution: The phenomenon of rising imports and lower domestic output can also be explained by increasing import substitution as a result of supply-side constraints (including in power) and elevated inflation (high domestic cost of production). Electrical machinery, rubber products and consumer durables are a few sectoral examples. 
 

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