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.
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