Reddy-ing for the elections: How Raghuram Rajan breaks from Subbarao legacy

Reserve Bank of India governor Raghuram Rajan is readying himself with ammunition to deal with any adverse post-elections scenario by buying dollars and building forex reserves, says a report in the Business Standard.

The report estimates that the central bank has added $5 billion since mid-March to its reserves by buying dollars from the forex market. It cites analysts as saying that the Rajan is readying the RBI to face the worst case scenario after the elections.

The worst-case election outcome is a fractured mandate, resulting in political and economic instability. The foreign investors, who are now pumping in dollars hoping for the best scenario, will pull out of the markets.

As per the latest weekly statistical supplement,the country’s foreign exchange reserves stand at $298.64 billion as of 21 March as against $297.29 billion a week earlier.

“It (the RBI) should be able to contain Rs 65/$ if a fragmented verdict leads to portfolio outflows,” the report quotes from a Bank of America Merill Lynch research note. As per the newspaper, by doing this, Rajan is breaking away from his predecessor D Subbarao’s legacy and returning to the practice followed by the former governors such as Bimal Jalan and YV Reddy.

Subbarao’s forex strategy has come under criticism after the unprecendented rupee depreciation duirng May-August placed the central bank in spot as it did not have enough dollar reserves to support the rupee.

In an interview to the Indian Express, economist Arvind Panagariya had called Subbarao’s term as “the worst era of performance by RBI governor”. He had said Subbarao should have built up dollar reserves when the rupee appreciated in 2009. The RBI was at a loss when the rupee fell to record lows when the FIIs pulled out of the market after the US Fed hinted that it may unwind its accommodative policy sooner than expected.

Clearly, Rajan does not want to commit this mistake, especially at a time when the US Fed has started tapering and also hinted at interest rate increases. So the RBI is now buying dollars to spruce up its reserves.

But apart from this, there is one more reason. An appreciating currency is a disincentive for exporters, since their earnings realisation falls to the extent to which the local currency rises. In January, India’s exports, which had risen after the rupee depreciated, had registered a decline. Analysts have pointed out that this could be because of the rupee appreciation. The RBI would not want to spoil that just when the exports are looking up. Moreover, exports are the only silverlining for most of the companies as the domestic demand is down due the slow recovery and political uncertainty.