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Moneylife » Economy & Nation » Economy » RBI must enter forex market to support rupee, curb inflation: BoA-ML

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

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MDT/PTI | 19/11/2012 11:26 AM | 

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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