How can RBI stop the rupee fall?

by Manshu on January 5, 2012

in Economy

The rupee has fallen quite a bit in the past few months, and the question on a lot of people’s mind is how can RBI stop the rupee from falling more?

Before we get to what they can do to stop the rupee fall – let’s get one big thing out of the way. The RBI cannot stop the rupee decline by selling dollars and buying rupees snf manipulating the market.

At a little over $300 billion – India’s forex reserves just cover 95% of the country’s external debt and more importantly – the market for the Rupee is estimated to be $70 billion a day, and RBI simply doesn’t have enough firepower to manipulate this market by trading in it.

As Ajay Shah writes in his Rupee FAQs – if RBI tries to manipulate this market they will run out of dollars very quickly. He further details what else can go wrong, and I think anyone interested in this topic should definitely read his full post. Probably, the best proof that Ajay Shah is right is the fact that RBI hasn’t tried to meddle in the market so far.

So, if RBI can’t trade in the market – what else can they do?

Anything, that makes it easier to bring in USD into the country will help ease the stress on the exchange rate, and stop the rupee from falling.

The impact of one step will not be immediate, and it may not even be very big, but these small steps are what will help arrest the slide, and these small steps also happen to be the only practical thing to do right now.

The most recent example of such a step is to allow foreigners to all investing in Indian shares directly – they could earlier invest only through participatory notes, and this makes it easier for them to invest directly, and will help bring more dollars in the country.

The other such move was to liberalize the NRE interest rates, and allow banks to set their own NRE rates. As soon as they did that – some banks increased the rates from as low as 3.8% to 9.5%! Since the interest income from this account is tax free for NRIs – this is a great incentive to open NRE accounts and deposit money in these accounts.

If they allow FDI in multi brand retail – that will also get companies to invest money in India and bring in some dollars in the country and that will ultimately help the exchange rate as well.

If you see these measures – none of them will bring down the high dollar rate overnight or even in a few weeks – even if foreign investors can invest directly in India they aren’t exactly queuing up to do that right now, and even if NRIs can open these accounts, it takes about 3 – 4 weeks to open an account and even then it’s a question mark on how much money they will actually transfer?

If there were quick and easy solutions, they would’ve been already implemented, but like all other things – the way to have a stronger rupee is to make fundamental improvements in the system that attracts foreign inflows, and boosts exports, and things like these can only be done over the long term with sustained efforts.

This post is from the Suggest a Topic page.

{ 7 comments… read them below or add one }

Kapil Dev Tejwani January 6, 2012 at 10:45 AM

Nice Post Manshu,
When rupee was 54 there was an article in ET which almost had the similar points like boosting exports and incresing inflow of dollar in the country.But these are measures which are difficult to implement for the election centred govt…they take measures only which can give them election advantage..So then the question is how do we expect these steps to be taken..

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Manshu January 6, 2012 at 7:43 PM

There are a lot of small things that can be done to improve the situation – for example – about one or two years ago RBI decided to impose so many rules on PayPal transactions that it made virtually impossible for most people to use it.

Now tens of thousands of freelancers who were coding from their hostels and shared apartments were using PayPal and doing projects for less than a $100 and earning some money. I’m sure a lot of those people found alternatives but a lot of the others simply stopped because it was no longer worth it. Get rid of this thing – go back to the old situation and make it easy again.

There must be several other situations where they can make doing things easier – it’s only when we abolished the license raj and liberalized the economy did we see the growth that we saw in the last 2 decades. Now, there is a serious risk of that growth being scuttled and adjusting to a permanent lower base like 6% or so.

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Kapil Dev Tejwani January 9, 2012 at 12:56 PM

Yes Manshu the paypal thing is a nice example.Way back in 2007-08 we (I and my brother) also used the paypal to get money for our online services and after some time there were stricter rules that left us helpless.

Yeah the growth worry worries me too, In some way India is looking very similar to Greece..So am just afraid it should not end up as greece..I plan to write a post about it on my blog soon.,Whats your opinion on India as compared to Greece in terms of finalcial health, culture(ie bribe vulture), govt hierarchy…Have got these ideas after reading Boomerang, the book suggested by you…It was an awesome read…thnks

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Manshu January 9, 2012 at 9:16 PM

All of those things you mention are very very familiar and that too in a scary way. For example, I read about AI changing its flights for a trip because Praful Patel and his family were to take that flight and the original plane didn’t have business class seating! Some of this stuff is just so so bad.

But coming to the Greece example, I think a big difference between Greece and India is the composition of external debt – in India’s case the government owes only about 25% of the total external debt and a large part of that is not going to mature soon or is from bilateral agencies so as far as I understand it – the chances of a debt default type of situation for India is very very low.

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Kapil Dev Tejwani January 10, 2012 at 12:50 PM

Thanks for reply Manshu,
Am just curious to find out where to get the details of govt debt owed by India.Is there any website which can enlighten on this aspect.
Yes it is really conforting to know that we are not bad in the worst situation right now.

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Manshu January 11, 2012 at 2:15 AM

Yeah this is present in the Ministry of Finance website. http://finmin.nic.in/

Under the data & statistics section linked External Debt.

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bemoneyaware January 18, 2012 at 12:18 PM

After hitting an all-time low of 54.30 against the US dollar on 15 December, the rupee jumped to close at 50.73 on Tuesday Jan 17. Interesting post on FirstPost:How the rupee went from 54 to 50 against dollar in one month
Quoting from the article:

1. Intermittent intervention by the Reserve Bank of India (RBI) by selling dollars in the foreign exchange market has helped remove the froth off speculation — and provided some support to the rupee

2. the freeing of interest rates on non-resident Indian (NRI) deposits by the RBI last year allowed banks to raise rates on such deposits, which attracted large flows from NRIs

3. Foreign funds raised holdings of Indian debt by $3 billion this month to a record $29.1 billion as on January 13, while investments in stocks rose by $559 million,

4. the goverment hiked import duties on gold and silver on Tuesday, which helped the rupee cross the 50-against-the-dollar- threshold as traders became confident that the measure would discourage imports of both precious metals.

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