Forex reserve shrinks as dollar shies from market

Tags: News

RBI intervenes to stabilise rupee in medium term

The rupee can expect support in the medium term only from the Reserve Bank of India’s (RBI) intervention in the forex market, as foreign investors take cover by investing in the US treasury rather than flock to emerging markets, including India.

India is dependent on foreign flows to finance its current account deficit and also protect the rupee.

Bankers confide that the central bank has been intervening in small volumes to check exchange rate volatility, and this has been depleting the country’s foreign currency reserves. Total forex reserves, as on December 14, stood at $296.63 billion, down from $320 billion in 2009-10.

Intervention apart, the value of other currencies held by the central bank have been depreciating as well, leading to the depleting reserves, bankers said.

This is happening at a time when major foreign investors, worried about the US fiscal cliff, are seeking safe haven in the US treasury rather than venturing abroad. In the process, they have also pushed the rupee below 55 to the dollar. The run on the rupee is expected to continue till issues surrounding the fiscal cliff are resolved.

Parthasarthy Mukherjee, head of treasury and international banking at Axis Bank said, “The rupee is expected to be under pressure due to global uncertainties surrounding the fiscal cliff and how it can be managed. Until then, foreign investors are going to stay risk averse. RBI will be the only support for the exchange rate until the global issues are solved.”

In the US, the term fiscal cliff is in currency, in reference to the urgency for imminent tax increases and spending cuts for a matching reduction in the Federal fiscal deficit, beginning 2013.

The deficit -- the difference between what the government takes in and what it spends -- is expected to be reduced by almost half, beginning early next year. For this the law must first be changed by this yearend, barely a week away.

Though the capital account in India is in surplus, we have a huge current account deficit as well as a trade deficit, resulting in a shortage of dollars. The twin deficits are financed by the foreign flows. Therefore, when foreign flows go up the rupee appreciates and vice-versa.

Standard Chartered Bank is confident of a bounce-back in the rupee once the issues surrounding the US fiscal cliff are resolved. “The RBI’s cautious approach to monetary easing is supportive of the rupee. The central bank is responding to actual improvements in inflation outturns rather than anticipating better news or rewarding policy reforms by the government. This not only boosts India’s economic policy’s credibility, but also underpins government security yields well above the levels prevailing in major developed, and many Asian, sovereign debt markets. From both perspectives, the RBI’s policy approach should promote the much-needed capital inflows,” said the bank in a report.

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