Fall of the rupee

The RBI seems to think movement of the rupee was exaggerated by speculative activity. Bimal Jalan’s statement of late last week makes this clear; he refers to “excessive sensitivity” in the market to even minor exchange rate fluctuations. Certainly, market overreaction has been a regular pattern in the past whenever some event has sharpened the rate of depreciation:

demand for dollars has spurted from banks, dealers and importers, and flows on export accounts have evaporated. These natural defense mechanisms are always amplified by speculative operations. But there should be no need for heartburn among importers and exporters. It has been explicitly said the measures are temporary.

Uncertainty stokes speculation and the RBI contributes despite itself to some of the uncertainty. How far it will let the rupee depreciate is difficult to judge. If there was no intervention, the market would conclude the fall is engineered. When there is intervention at a time of exchange rate volatility the tendency is for the market to posit a target or band which the central bank will defend. Jalan has gone to great lengths to disabuse the market of that notion. At the same time he has tried to eliminate any cause for nervousness about foreign exchange reserves.

Reiterating that the RBI does not target a specific rate for the rupee against the dollar, he said, “The often cited round figures of Rs 42, Rs 43, or Rs 44 simply have no significance for management of the exchange rate by the RBI”. That is not exactly how the market sees it. A policy of controlled depreciation such as the RBI is widely seen to pursue means the “round figures” do have significance depending on the rate at which theyarrive. Unpopular or not, the RBI’s actions are likely to squeeze the panic out of the scenario. It also helps that economic fundamentals are sound and the prospects for export growth and capital inflows are good.