The RBI has been buying large amounts of dollars in the foreign exchange market in order to prevent rupee appreciation. Unfortunately, its intervention has failed to achieve this objective and the rupee has been strengthening sharply in recent months. The latest measure by the government, in its struggle to keep the rupee weak, is a proposal to curb foreign capital inflows through Participatory Notes (PNs). The data shows, however, that contrary to the impression that PNs are responsible for the upward pressure on the rupee, the inflow of dollars through PNs has been only a small part of the story.

Further, the step to block capital flows in order to slow down rupee appreciation will signal that the rupee remains a one-way bet. This will encourage more capital to flow into India.

Here we compare data on FII net inflows from SEBI with data on net purchase of dollars by the RBI. The data shows that RBI’s purchase of dollars has been much more than net FII investment into the debt and equity markets in India. PNs are only a part of FII flows and reducing flows through PNs or even blocking them altogether would not have made a significant dent on the amount RBI would have bought in trying to prevent rupee appreciation. In the last 11 months, between November 2006 and September 2007, FIIs brought in a total of USD 17.5 billion into India. However, RBI spent more than three times this amount on manipulating the rupee. It bought USD 56.7 billion in the foreign exchange market in this period.

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