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Thursday, March 13, 2008

$22 billion of RBI purchase in January

I had blogged yesterday on the subject of interpreting the recent INR depreciation. And, earlier, I have written about the new phenomenon of RBI building up a large forward position.

New data has come out which validates this analysis. In January, the INR was basically unchanged: starting at 39.41 on 2 January and ending at 39.3 on 31st January. How did this come about? It required an unprecedented scale of purchase by RBI, both on the spot and the forward market. They purchased $13.6 billion on the spot, and the forward position grew by $8.4 billion!

In January, net FII flows were negative. Why, then, did it take $22 billion of USD purchase to maintain a flat exchange rate, even after capital controls have been brought back on ECBs and PNs in 2007, thus drastically curtailing these? The answer lies in India's deepening de facto convertibility. Capital controls that target any one element of capital flows might seem to work, but money will come through by other channels.

This links up to the case for a rate cut. The deep case for a rate cut is that India's 500 basis point interest rate differential against the US cannot be supported when India pegs the rupee to the US dollar. RBI is in an extremely uncomfortable position with the implementation of the pegged exchange rate, as long as this large interest rate differential is in place. The only way to reduce the discomfort of pegging is to lower interest rates. This is all about the loss of monetary policy autonomy that pegging induces, and has nothing to do with whether or not there is a business cycle slowdown.

This data about January trading by RBI was released today, i.e. 13 March. This big lag is part of the larger problem of RBI transparency; the delay helps to impede thinking and policy discussion about the difficulties of implementation of the exchange rate regime. Play the thought experiment in your mind: Suppose this shocker of January data was in the newspapers on 1 February. Or even better, suppose RBI was as transparent as FIIs are: suppose that RBI trading is disclosed every day. The process of policy analysis, policy discussion, and the external constraints that would come upon decision making at RBI would kick in much faster. Instead, with the present environment of non-transparency, information comes out with a huge lag, by which time the decisions are already made, and public policy discussion is stifled.


  1. Sir,

    With inflation soaring again, would a rate cut be a sensible thing to do ?

    Why do you argue for rate cut rather than loosening the USD a bit (to say 36 levels) ?

    I am sure that would cause problems in few sectors but that is the cleanest thing to do.

  2. I do not believe that exchange rate pegging is the sensible strategy for India. But if pegging must happen, then there should be no illusions about monetary policy autonomy. This interest rate differential is infeasible.

  3. Sir,

    My base case is.. pegging shouldnt happen. They can keep the rates high but they shouldnt peg.

    Its either inflation or jobs

    They cant have both now. I say..control inflation (by freeing the peg a bit more) and sacrifice jobs

    NS Capital Partners

  4. who is playing the OIS curve? this is where most of the 500 bps action would be. Last year Pimco was big player on OIS

    would rather see rupee appreciating than hiking up rates (but fx players will make up for the loss of interest differential by fx gains)

  5. Sir, would you be interested in linking up to

    I already linked up yours.....I am maintaining a list of business blogs

  6. i think RBI intervenes in the currency markets on a gross flow basis and not on a net basis.

    So in January, the RBI would have intervened during the Reliance power IPO. But the net fii month end number was negative due to outflows seen in the later part of the month.

    thus comparing the intervention number against the 'net' month end fii flow number would give a wrong impression

    though i completely agree with the data lag part. it should be revealed either every day or in the wss.

  7. Ajay,

    S&P has launched an Real time Indian Rupee Index and a similar product for the Chinese Remnibi.



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