What will the RBI do now?

Tue, 2 Jul Pre-Open

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Indian rupee is on a bumpy ride. Recently it touched the 60 dollar mark. Sudden and massive depreciation in home currency can have a cascading impact on any economy. Rupee deprecation has an impact on both individuals as well as on corporates.

Rupee depreciation makes imports expensive. As a result, cost of imported items rises and this has an impact on the individuals in the country. On the other hand corporates that have dollar loans on their books are negatively impacted by rupee depreciation as their dollar liability increases. At the same time, corporates that are net importers stand to lose out.

However, depreciating rupee favors exporters. But with global economy slowing demand has moderated. As such, exporters have not really benefitted from the fall in the rupee. It should be noted that along with rupee most other emerging market currencies have also fallen. Thus, on a relative basis Indian exporters are not at an advantage when they are competing for exports with other countries.

Rupee depreciation fuels up inflation too. For instance, India imports majority of its fuel requirements. Depreciating rupee increases fuel costs. This stokes inflation. And rising inflation interferes with Reserve Bank of India's (RBI) monetary policy actions.

Fall in rupee has an economic impact as well. With fuel prices being regulated in India if the rising cost of fuel is not passed on to the customers the subsidy burden on the government could increase. This worsens our fiscal deficit situation.

So, what can RBI do to arrest the fall in rupee?

The obvious answer would be to sell dollars. However, with India's dollar reserves shrinking this does not seem like a very good idea.

It may be noted that exchange rates between any two currencies is a game of demand supply. Thus, any measure that increases demand for rupee or supply for dollars should help. Sucking out liquidity from the system will reduce the supply for rupee. This can arrest rupee's fall. However, liquidity tightening in such an environment where corporate growth is suffering may not bode well.

It may also be noted that the current depreciation is accentuated by speculation. As such, RBI can take steps to arrest that. As highlighted by the author in an article in Live Mint, RBI can withdraw the facility to cancel and rebook forward contracts. This can help as it curtails unnecessary speculation in the currency market. Other measures include raising rates on NRI deposits. This can attract more dollar deposits into India.

While all these measures can help in the short term the long term solution is to improve economic growth. If growth improves foreign capital will chase India. This will not only boost the equity markets but also help rupee. Long term capital will bring more stability to both equity and currency markets.