The Indian rupee has been extremely weak recently. The currency crossed 60 late last month i.e. it would take over 60 rupees to buy one dollar.
To curb exchange rate volatility the Reserve Bank of India surprised markets by increasing its key in benchmark interests rates by a whopping 200 basis points. The Marginal Standing Facility (MSF) rate to 10.25%, and the Bank Rate was also increased to 10.25%.
The central bank also decided to sell government bonds in the amount of Rs. 120 billion ($2 billion) through open market operations.
This move to tighten liquidity helped support the rupee which strengthened by 0.9%.
The rupee has also been hurt by the nation’s current account deficit problems, which policymakers attribute to massive oil and gold imports. This makes India vulnerable to external funding risks. And the nation’s fiscal deficit also hurts the economy.
“The market perception of likely tapering of US Quantitative Easing has triggered outflows of portfolio investment, particularly from the debt segment. Consequently, the Rupee has depreciated markedly in the last six weeks.
“Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals. The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in part because of the improving domestic liquidity situation.”
But the net outflow of foreign investments in India has been unprecedented, according to Lombard Street Research’s Shweta Singh. Foreign investors pulled $7.5 billion out of the market in June. But she thinks the sell-off in the rupee has been overdone because India has less commodity exposure than other underperforming currencies like the South African Rand, the Brazilian Real, the Russian Rouble.
While the central bank’s move to tighten liquidity and bolstered the rupee “by making it more expensive to speculate and by attracting more investments in bonds,” Singh doesn’t think the measures will work in the long term.
“Foreign investments are skewed towards growth-sensitive stocks rather than bonds. As tighter liquidity conditions choke off already modest growth, foreign investments may dwindle further, putting pressure on the Indian Rupee.”
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