Rupee at 62: Raghuram Rajan is preparing for a big fight

Raghuram Rajan came into office in September 2013 just when the rupee was fighting one of its toughest battles.

The currency had sunk to a lifetime low of 68 to the US dollar, when it was trading at 54 five months back. The new RBI chief had then waded straight into the battle: bringing about several financial reforms right off the bat as well as taking innovative steps to attract US dollars from abroad.

Within a few months, the rupee came and stabilized at around 60-61 levels where it has hovered since - and the RBI chief then got busy fighting another battle, this time with prices.

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But having largely put the inflation genie back into the battle, it appears Rajan will again have to shift his focus back to the rupee, after the currency fell to a 10-month low in trade to 62.33.

Unlike the story back then, when at least partially the rupee fall could be attributed to local macro economic factors - weak economic growth, ballooning deficits and high inflation - this time it appears the story is of US dollar strength rather than rupee weakness.

This has been driven by a resurgent US economy, which has led to the Fed start to unwind its ultraloose monetary policy, and overall weakness in other developed countries, as well as in China.

The US dollar index, which tracks the greenback’s strength against a basket of six major currencies, has risen about 13.5 percent since bottoming out in May this year but the rupee has fallen only 7.3 percent in that time.

The rupee’s relative strength has been because of dollar inflows into the country, thanks to the fact that global investors are again looking at India as a great place to invest, Jamal Mecklai of Mecklai Financial Services told C_NBC-TV18_ yesterday.

So while inflows are currently blunting the broad dollar strength, it appears the RBI is busy preparing for a rainy day.

“If we are faced with a globally strengthening dollar, then I do not really think the RBI will be putting in too much ammunition in defending the rupee,” LIC Nomura MF debt fund manager Killol Pandya told the Economic Times recently. “It probably let the currency slide a little more before it draws a fresh defence line for the currency.”

And drawing a fresh defence line it is, since March this year, the RBI has been busy buying US dollars from the open market in billions. In July, for instance, it purchased as much as $5.45 billion, while most other months too, it has been a net purchaser. The central bank’s foreign exchange reserves are near an all-time high of $318 billion.

The most RBI has done is come into the market to sell US dollars when it was seeing volatility rise, such as yesterday. In short, it is saving up on its bullets.

The larger plan is obvious here.As long as the rupee slides gradually and without much volatility, the RBI will not mind it, and it would also help exporters , Federal Bank treasury president Ashutosh Khajuria told the Business Standard.

Time and again, the RBI chief has warned of a steep reversal in flows should the US start to reverse its monetary policy stance in a big way. The resultant currency volatility could seriously harm emerging economies.

In fact, it was this very point - that the Fed should be mindful of the effect its policies may have on emerging economies - that saw Rajan get into a minor war of words with former Federal Reserve chief Ben Bernanke (who was sitting in the audience during a discussion among top central bankers around the world). Bernanke, along with a former colleague in the Fed, essentially responded by saying the Fed’s prerogative lied with the US economy and other nations are on their own.

It appears, that on his own, Rajan is preparing for a big fight in 2015.