Representative image: Source: Reuters
The Indian rupee has made a smart comeback in the past two weeks, gaining more than 1.5 percent against the dollar. While the recovery has been attributed to the cooling of oil prices, much of the credit actually goes to the Reserve Bank of India.
However, that does not entirely explain the $ 11.1 billion drop in the country’s foreign exchange reserves in the week ended March 11. The central bank’s data showed that this was the biggest drop in two years. Market participants say the central bank has stepped up its market intervention in addition to the scheduled dollar sales through the swap arrangement.
Sentinel at the gate
In September 2013, the RBI introduced a special concessional swap involving foreign currency non-resident deposits of banks. Through the FCNR swap, the central bank enthused banks to raise dollars and swap them at a concessional rate with the RBI. This swap resulted in $ 34 billion flowing into the domestic market. The arrangement helped shore up the country’s forex reserves.
However, such an arrangement is unnecessary in the current context. Unlike in 2013, India’s external position is robust and the RBI has a record pile of forex reserves.
Going to the basics
The RBI’s market interventions have intensified over the past decade. Between FY04 and FY13, the RBI bought an average of $ 3 billion every month from the market. It sold $ 2.5 billion every month, an analysis of data from the central bank shows. This has almost doubled to average monthly purchases of $ 7 billion from FY14 to now.
It should not be surprising then that the RBI has come under the glare of the US Department of the Treasury. The US termed India a currency manipulator since the RBI’s interventions were close to 5 percent of the country’s gross domestic product (GDP).
Foreign portfolio outflows
There are, of course, pitfalls of too much intervention. Incessant dollar purchases tend to give foreign investors a lucrative exit from the domestic market. This could exacerbate outflows. Foreign portfolio outflows have risen to $ 6.3 billion so far in March from $ 5 billion in February and $ 2.8 billion in January.
Moreover, meddling in the forward market renders contracts is expensive for importers and exporters, depending on which side the central bank is on. Most of all, the cost of intervention is a setback to an otherwise straight path to a liberalised external sector that attracts foreign capital without any hang-ups.
That said, in the absence of a deep and developed domestic market, emerging economies such as India have no choice but to keep interventions sizeable.
For the rupee, this gives considerable protection against future volatility. At the tactical level, the central bank may ease its hold on the market during brief periods. A more decisive shift towards a freer market would, perhaps, have to wait longer in the wake of the current uncertainties.
