Arresting the slide in Indian Rupee

Indian Rupee on Monday gained marginal strength to finish the day at 51.875/880 per US$ midst expectations that RBI intervened in the market to arrest the slide and will remain keenly involved to keep the Rupee away from high volatility. Since data for RBI intervention comes with a two month lag nothing can be said for sure. However, since people from all quarters are calling for RBI's intervention a look into RBI's fire power might show reasons of its reluctance in intervening as it has clearly signaled.

• RBI presently has $308 billion of forex reserves which is marginally lower than $314 billion that RBI had when the crisis of 2008-09 struck. This is the situation when the recession 2.0 seems to be knocking at doors of global economy. RBI needs to have enough forex reserves to fight the tough weather that is one reason it is going slow at market intervention at this point of time. 
• Around $142 billion of these reserves are on account of FIIs who are known for their flight for quality and this is one reason why Rupee is showing such a fall. FIIs are exiting quickly to turn their assets in $, the safest currency. That's why October saw a net FII outflow. Apart from this quite a large sum is made up of short term external debt and NRI deposits. In total around 88% of Indian forex reserves can be labelled as volatile with a tendency of flight to hard currency in times of crisis. Even though not all of this reserve will vanish in case of crisis still this limits RBIs firepower to great extent.
• Indian exports have slowed but imports are not showing any signs of slow down. Apart from this prices of POL which form around 30% of our import aren't showing any signs of calming added with the pinch of falling Rupee they are pushing our import bills up. Indian reserves at the moment are sufficient only to pay for 9.6 months of import, lowest since 2001. That too limits RBI's intervention abilities.
• Apart from this Indian current account deficit is widening on account of soaring import bills and weakened exports. It was 2.6% of GDP in March 2011 and is expected to be higher for the FY'12. This deficit needs to be financed. Till now Capital account surplus has very well taken care of the deficit. However, in worst case scenario RBI may have to draw down on its reserves to finance the deficit. The central bank needs to be prepared for that too.

All this limits the power RBI commands for intervening in the forex markets. This is why both govt. and RBI have geared up to increase the forex reserves. Opening up of the retail sector for 51% FDI is one such move. Not only will it bring competition, quality and lower prices but also, foreign capital which will be here to stay. Prior to this govt. has raised ceilings of FII investment in govt and corporate bonds. RBI has increased the maximum interest rate that banks can offer on NRI deposits an also raised the maximum rate at which Indian Companies can borrow from overseas market. These measures of RBI increases the possibility of roll over of NRI deposits and short term external loans. Thus, volatility of our forex reserve decreases too. However, the steps are meant for much more. Many more such steps are needed to increase Indian forex reserves to comfortable levels. Apart from this we need to push for more reforms to re instill FII confidence and improve investment scenario. It isn't easy to be a central bank governor when economy is facing inflation and threats of slow down simultaneously. We must have faith on Dr. Subbarao that he will not allow Rupee to be a victim of Speculation and handle the economic crisis with same merit as he handled it in 2008.

P.S. The silver lining of slower economic reforms in India is that Indian Rupee isn't fully convertible. Thank God Indian Rupee isn't fully convertible else the slide in Rupee would have been steeper as domestic investors more aware of the situation would have been the first to escape to safe heavens with turning their assets into $.