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.

But why go all the way to pushing the rupee to depreciate? One possible answer is that too much money is coming in, trying to take advantage of the one-way bet and interest differentials with respect to the US. There was money to be made by borrowing in the US and lending in India. Interest rates in India are higher and if the rupee was also going to get stronger, dollar returns would be even higher. In this situation, the RBI might have tried to break the one-way bet by pushing the rupee to depreciate.

... contd.