Engineering of the rupee

The month of February saw the US dollar weaken against world currencies. It fell against most major currencies in the world including the euro, the British pound and the Japanese yen. This would have led us to expect that the Indian rupee would also appreciate against the US dollar. But this is not what happened. February 2008 saw the Indian rupee depreciate. Does this suggest a reversal of the direction in which the rupee will move? Have dollar inflows into India gone down and is that why the rupee is depreciating?

A look at the data suggests that the pressure on the rupee to appreciate is as strong as ever. What does the data tell us? If the depreciation of the rupee had been due to an outflow of capital putting pressure on the rupee to depreciate, there would have been either no change in the foreign exchange reserves held by the RBI (other than a small valuation/interest accrual change) or foreign exchange reserves should have declined as the RBI fought off the sudden pressure to ensure a smooth rupee.

However, data from the RBI suggests quite the opposite. There was a sharp increase in the foreign exchange reserves of the RBI. In the month of February, reserves increased by 11.7 billion dollars. In the first two months of 2008, foreign exchange reserves have already increased by USD 25 billion. In other words, this suggests that the depreciation of the rupee was engineered.

After the cut in interest rates in the US since mid-2007, there has been a sharp increase in the interest differentials with India. This could be expected to lead to a sharp inflow of capital into India and a rupee appreciation.

How, then, did the rupee depreciate in February? The RBI has intervened not only as it normally does in the spot market, but also in forward markets. Keeping the rupee above Rs 39 per dollar has clearly been a big battle. This is visible from the large amounts of intervention that the RBI has undertaken in the last few months. Table 1 shows RBI’s purchases in the dollar market. Between September and December, RBI bought a total of USD 55.7 billion in both the spot and forward markets.

The RBI will release foreign exchange market intervention data for January and February with a lag. What we have today, however, is data on changes in foreign exchange reserves. Foreign exchange reserves rose by 12.7 billion in January 2008, and by 11.7 billion in February 2008. Given the large spot purchases, it would not be surprising to see that the RBI also used the forward market to push the rupee down.

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