While the rupee movement may fool some people for some time into thinking that there will be a depreciation, smarter market participants will not be fooled for long. Everyone is aware that this pace of intervention is unsustainable. Embarking on strategies like intervening in forward markets reveals the RBI’s desperation. It builds up even stronger expectations that at some point, when too much pressure builds up, the RBI will have to let go.

In summary, while the rupee did depreciate in February, it did so on the back of trading by RBI and not market forces. This is a poor path in economic policy. There is a market distortion where the price of the rupee is too low. Easing this distortion requires a rupee appreciation. An artificial depreciation of the rupee is a step in the wrong direction. Intuitively, it is as awkward as a decision by the ministry of petroleum to cut the price of petrol when the world price of oil is rising.

Moreover, a rupee depreciation is inflationary. It is not a credible stance of monetary policy because it is politically incompatible with impending elections. It is obvious to market participants that this is an unsustainable policy. The profits from betting on rupee appreciation, as seen for capital coming into the country, are now bigger. With a combination of a large interest rate differential and a large distortion in the rupee, foreign capital now sees India as an extremely attractive opportunity to make a profit by exploiting the mistakes of monetary policy.

... contd.