Since the end of March, the Indian rupee has fallen from Rs. 44.65 to Rs. 50.90 to the US dollar—a 14% drop in less than 8 months!
This rapid decline raises two major concerns. The first relates to the rate of change—such rapid changes in rupee exchange rates are not good for business or economic activity. The second relates to the nature of the change—a weak rupee increases both inflationary pressures and the fiscal deficit (mainly because of the increased cost of oil imports).
While the RBI has reportedly intervened in the foreign exchange markets by selling US dollars (mainly to reduce volatility), the Ministry of Finance has sought to bolster demand for the Indian rupee by increasing the caps on foreign institutional investor (FII) holdings in government securities and corporate bonds. Each of these caps has been increased by US$ 5 billion, i.e., to US$ 15 billion and US$ 20 billion respectively. (Prior to this move, investment levels were fairly close to the earlier limits on FII holdings in these two classes of securities.) The RBI has also asked banks to clamp down on allowing their customers (primarily retail) to make margin payments for internet-based overseas foreign exchange trading.
At the same time, the RBI is also working to ensure that Indian banks and traders are better able to weather tightening liquidity conditions and widening credit spreads in international market. To that end, on November 15, 2011 the RBI increased (until March 31, 2012) the all-in ceiling permitted on various trade credits and advances (by 150 basis points). The RBI has also liberalized the rules allowing traders to set-off payables on their imports against receivables on their exports.
While these measures are all welcome, they may be insufficient. Policy makers would be well advised to look at introducing more structural changes that will address the gathering storm of high inflation, high interest rates, reducing growth rates and a rapidly falling Indian rupee.