A section of the market believes the rate increased was necessary to ward off a rupee collapse in case of a financial market upheaval. The Indian currency opened at Rs 63.19 to the dollar in the morning, but shaved off the early gain to end the day at Rs 62.50 after a forward guidance indicated a peaking of rates.
Naresh Takkar, MD and CEO of Icra, said, “The hike in the repo rate (by RBI) may also support the rupee in case of adverse external developments.”
According to new agencies, currencies of other emerging economies also staged a comeback. “Turkey’s lira added 0.7 per cent before a central bank meeting. Russia’s rouble halted a three-day loss and the South Korean won snapped a six-day slide,” said a report by Bloomberg.
There was a huge sell-off in the government securities as the market was jolted by the unexpected RBI decision. However, the bond market recovered with the 10-year benchmark bond closing at 8.75 per cent.
Soumya Kanti Ghosh, chief economic advisor of SBI, said, “Possibly the primary reason for RBI to increase rates was to ward off a contagion in the financial market. This has been done to make the arbitrage opportunities between foreign and domestic debt adjusted for currency risks compelling enough to encourage FII debt flows back to India. However, the events of the day show the opposite, $876 million outflow, predominantly from the debt segment.”
Between May and September last year the news of tapering of the quantitative easing in the US led to a rapid deterioration of financial conditions in emerging markets, including India.
According to the policy document released by RBI on the day, ‘the rupee exchange rate depreciated by 17 per cent against the dollar, amid a foreign exchange reserve depletion of nearly $17 billion.”
To stop the rupee from sliding further, short-term rates were raised by increasing the marginal standing facility (MSF), RBI’s penal borrowing window where banks can borrow overnight money at a higher rate of interest.
Since then, the rupee has appreciated by 6.7 per cent (till January 27) and the reserve loss has been more than fully recouped. Capital flows have resumed, with net investments of $9.1 billion in equities between September 4 and January 24.
Though there were large disinvestments in the debt segment aggregating $14.5 billion between May 22 and November 30, debt flows have turned positive thereafter with net investments of $3.8 billion.