Big Moment: RBI rescues rupee, but for how long?

The rupee’s intra-day slide on Wednesday to 48.02 against the dollar, a level not seen since September 2009, is a vivid reminder of how an economy, even if not heavily dependent on external trade for growth, can get deeply affected by global financial turbulence.

The rupee’s fall was so steep the Reserve Bank of India reportedly intervened in the currency markets and sold dollars to stem the currency’s slide. That is something the central bank has not done since the Lehman crisis of 2008. One CNBC report said the central bank could have sold $100 million - $200 million to defend the rupee. The rupee later recovered to close at 47.65, a 16-month low.

As long as the euro zone crisis festers, the currency will continue to remain under pressure. Currently, the fall is more because of sentiment rather than any fundamental fears about the currency or the economy. Frightened by the potential impact that a deepening sovereign debt crisis in Europe will have on the global economy, investors will keep seeking ‘safe havens’ such as the US dollar, while dumping riskier assets such as emerging market currencies. (It seems ironic, however, that while the major economic crises and higher risks are essentially concentrated in developed nations today, the assets of emerging nations get tagged “riskier”.)

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[caption id=“attachment_84412” align=“alignleft” width=“380” caption=“Currently, the fall is more because of sentiment rather than any fundamental fears about the currency or the economy. Reuters”]  [/caption]

So how low could the rupee go? It’s hard to say at the moment, although some experts believe the central bank’s intervention indicates the rupee is unlikely to fall much lower than 48 against the greenback. Don’t bet on that though, because as a policy, the RBI likes to have a hands-off approach in the currency markets. It only intervenes in extreme situations. And the depreciation of recent days, when the rupee plunged from 46 to 48 against the dollar in a matter of three days or so, certainly qualified as an extreme situation.

Jamal Mecklai, chief executive officer of Mecklai Financial Services, a foreign exchange services firm, believes the rupee could fall to 50 against the dollar in the short term if Europe’s economic problems are not resolved soon. US-based investment house JP Morgan has also said the rupee could test 49.20 against the dollar if the 48-mark is breached. It also added India’s poor trade deficit numbers were worsening sentiment towards the rupee.

HDFC Bank also sounded glum as it said in a research note:“The bottom line is we see very little support emerging for the rupee in the near term… given the pace of the current momentum, a possible near-term upside of 48.50-48.70 cannot be ruled out.”

The currency, however, may get some support from meeting between the central bank and the government today to consider raising the overseas borrowing limit beyond the current $30 billion. A hike in the cap could help improve dollar liquidity and support the rupee over the medium term.The rate-setting meeting by the RBI tomorrow could also provide firmer direction for the currency.

Economically, the depreciation couldn’t have come at a worse time. Typically, a fallingrupee tends to boost exports. But given the global economic slump, that seems unlikely.

Barring the IT sector, most other sectors will be unable to capitalise on a falling currency to boost overseas demand or margins. On the other hand, the country’s import prices are likely to increase in terms of dollars and lead to a further worsening of the trade deficit (the gap between what is earned in exports and what is paid for imports). That means if global commodity prices fall, there’s a chance that India might not benefit because it will still have to pay more in terms of rupees. Indeed, it could also ‘import" inflation at a time when price levels are still high.Already, oil marketing companies have said that a falling rupee is raising the cost of imported oil and are seeking a Rs 3 hike in petrol prices per litre. India imports more than 70 percent of it crude oil requirements.

Still, it has to be remembered that these are all short-term problems for the rupee. In the medium- and long-term, the currency should gradually appreciate because of rising portfolio and direct investments due to good economic growth prospects (over 9 percent a year in the medium term).

The near-term outlook may be muddied, but the long-term outlook remains sunny.