Mumbai, April 13: Two positive developments on the foreign exchange front have emboldened the RBI to continue the buying dollars at the risk of rupee depreciation.
One factor is the strong FII inflows that have led to the stock markets breaking records almost every day; the other is a strong real effective exchange rate of the rupee — encouraging the RBI to buy dollars at the expense of depreciation to improve India’s foreign exchange reserves and import cover, shielding the country against any external shocks.
Foreign exchange reserves in March had crossed the $300-billion mark at $303 billion, the highest since December 2011.
Besides FII inflows, the higher real effective exchange rate based on the consumer price index has goaded the apex bank to mop up dollars.
“The just-released CPI-based real effective exchange rate (REER) shows that the rupee is almost as strong as 2008 when the RBI was buying foreign exchange to prevent appreciation,” Indranil Sen Gupta, chief economist, India, at Bank of America-Merrill Lynch, said in a note.
Recently, the apex bank said it would compute and release REER only on the basis of the consumer price index (CPI) from this fiscal. This follows a shift in the RBI’s focus to retail inflation over wholesale price index (WPI) inflation in the formulation of the monetary policy.
REER indicates the movements in exchange rates of the domestic unit against a basket of currencies of trade partner countries and is considered to be a pointer to international competitiveness.
Usually, an increase in the domestic price index results in an appreciation of REER.
According to the Bank of America-Merrill Lynch, the six-country CPI-based REER showed that the real value of the rupee has appreciated 11.4 per cent since 2004-05 in contrast to WPI-based REER that shows a 4.4 per cent depreciation. This is largely because of the fact that CPI inflation is ruling above the WPI inflation.
Foreign portfolio investors have shovelled more than $5.2 billion in both equity and bond markets so far in this calendar year. Market circles maintain that the inflows are likely to remain strong with the Indian economy poised for a recovery. This could lead to a further appreciation in the rupee.
Hopes of the business-friendly NDA government assuming power at the Centre have already sent the key stock market indices soaring to record highs. Optimists believe that this can also lead to the rupee hitting the 55-mark against the dollar.
However, others maintain that the central bank is unlikely to allow the rupee to appreciate to that extent as it will continue to intervene by buying dollars from the market.
On Friday RBI governor Raghuram Rajan gave an indication to this effect when he said at a conference in Washington that though the country had enough foreign exchange reserves, no nation could fully insulate itself from external vulnerabilities.
“We are well-buffered with substantial reserves, though no country can be de-coupled from the international system,” he said.
India’s import cover of its forex reserves now stands at around eight months. The RBI is expected to take it to at least 10 months.