RBI & DOLLAR RELATION

The Reserve Bank of India sold $20.6 billion in October, according to the figures published in the December bulletin of the bank.

It was during October that the local currency faced severe pressure. The currency declined from about 47 to the dollar at the beginning of the month to a little over 50 at the end of October. The decline in forex reserves during that period had prompted speculation that the RBI was ‘intervening’ massively to prop up the local currency.

The super spike in oil prices on the one hand and flight of capital on the other have been the two factors that saw the RBI furiously sell off dollars to prop up the rupee, according to Dr D.K. Joshi, Director and Principal Economist at rating agency Crisil.

The RBI has so far in this fiscal sold close to $34 billion while purchasing $5.68 billion. The net sale of $28.3 billion would mean that an equivalent amount of Rs 1,20,000 crore has been removed from the banking system – causing some liquidity crunch before the announcement of recent liquidity infusing measures.

Why RBI buys

The RBI buys dollars in the market when there is a heavy inflow of dollars – as was the case in the last few years. This is done to prevent the rupee from appreciating beyond the level that the RBI is comfortable with. A considerable part of the liquidity enjoyed by commercial banks during the past few years owed its origins to the dollar inflows that were sucked out by the RBI.

By placing rupees in their hands and once again ‘sterilising’ it by selling government paper to banks, the RBI was hoping to keep inflation under control.

During 2006-07 the RBI did not sell any dollars in the market. In 2007-08 also the RBI remained a purchaser of dollars – except in March, when it sold about $1.4 billion. During these two years alone, the RBI had purchased about $100 billion – which got added to the country’s forex reserves.

The RBI was also very active in the forward market for dollar purchase from October 2007 when the inflows were high. Its outstanding net purchase of dollars in the forward market was at a high of $17 billion in April 2008 after which it has gradually reduced the net position to a mere $90 million in October 2008.

Since June this year, the RBI has had to intervene actively and sell more dollars than what it purchased during each month. There was a brief reprieve in August but things have taken a turn for the worse after that.

Volatility to continue

According to Dr Joshi, the nascent, if hesitant, uptrend in rupee in recent times should relieve the pressure on the Reserve Bank to continue to aggressively engage the market.

The drop in oil prices has come in as a major stress-buster, but Dr Joshi was apprehensive that the exchange rate scenario would continue to be volatile with each passing day bringing out varyingly depressive forecasts on global finances.

But he struck an optimistic note with a hunch that capital flows should begin to trickle in sooner than later. And that next year would not require the RBI to be as active in the market as it has been throughout year 2008.