Wake up, UPA! Time to step up and defend the rupee

Despite the central bank jumping in to save the plummeting rupee, the Indian currency breached the psychological 54-mark against the US dollar on Tuesday.

The rupee recovered from the day's low to trade at 53.78 per dollar, gaining 19 paise from the previous day's close of 53.97 as the Reserve Bank of India (RBI) reportedly sold dollars through state banks.

Everyone is clearly worried about the plunging rupee. In a survey, chief financial officers of leading companies in India said they though currency fluctuations are the biggest threat to growth, according to a report in Financial Express.

With good reason. A falling rupee increases the threat of inflation and limits space for the central bank to cut rates further.The RBI is clearly doing everything it can to save the rupee. It has sold dollars, eased limits on bond market investments to attract foreign funds and directed exporters to convert up to 50 percent of their foreign currency holdings with banks into rupees within a fortnight, among other measures.

A falling rupee increases the threat of inflation and limits space for the central bank to cut rates further. Reuters

Now, there is speculation that the RBI might issue government gold bonds to attract dollar inflows and stabilise the rupee which is in danger of hitting fresh lows.

The central bank sold $20 billion in the spot market in 2011-12 to prop up the sliding rupee. On top of this, it has also sold dollars in the forward market, with cumulative net forward sales touching a high of $3.23 billion in March.

But the RBI can't continue selling dollars forever to prop up the rupee. It has to stop sometime.

The rupee's weakness has been driven by a soaring trade deficit, dwindling portfolio flows and overall dollar strength as well as growing global risk aversion. The risk aversion is growing because of fears that the exit ofGreece from the 17-nation common currency union could also have a domino effect on other weak links such as Portugal, Spain or Italy.

As a Firstpost article earlier pointed out, direct currency intervention cannot prop up the rupee indefinitely and it is best to let nature take its course. In the end, the RBI's efforts, though persistent, are likely to have just a limited effect.As anEconomic Timescolumn notes:"RBI can only make peripheral impact on the currency. Only the government, if it musters the courage, can make a difference."

In an interview to CNBC TV18, Sanjeev Prasad of Kotak Institutional Equities echoed that sentiment by saying that he believes the central bank is not in a position to defend the rupee strongly, and that the rupee needed action from the government to recover sustainably."So far global investors have still been very patient in India solely watching them lose money in terms of currency but the worry is the government is not reacting to all sorts of negative news," he said. "Somebody has to wake up and start taking control of events."

The problems of the eurozone may be one thing, but there are several other issues that can be fixed by the government.

Prasad warned that Greece exit from EU could lead to significant turmoil and all asset classes may correct thereafter.