RBI intervention

The rupee has depreciated rapidly in the last month to a new high for last year. It toughed to a new high at 49.50 per dollar in the forex market. The depreciation in the market has multiple implications in the Indian economy. RBI is under pressure from different players in the economy to intervene and stop further depreciation of Indian rupee.

On one hand, the depreciation of rupee leads to the increase in import bills, especially petroleum products which is largely imported by India. Another important consequence of the depreciation of rupee would hit the corporate who have large External Commercial Borrowing (ECB). ECBs are good way to raise money from foreign market due to cheap rates and stable currency. But this also lead to forex exposure. The corporate who have ECB unhedged forex exposure are finding it difficult to pay high rupee amount.

Also, the corporate raise money from foreign market by using another instrument called Foreign Currency Convertible Bond (FCCB). FCCB is similar to a other convertible bonds which pays regular coupon with a option to convert the bond into equity at maturity at pre-fix price. If the equity price is higher than contracted conversion price, they can convert the investment to equity. And, in case equity price is lower than contracted price, then bond holder will be paid at contracted price. Due to boom in the last decade, many corporate raised FFCB from the foreign market in early 2000. They are finding it difficult to repay the bond holder with depreciated rupee.

For quite some time inflation is the main concern for the Indian economy and the Reserve Bank of India (RBI). The Indian industry and consumers buy a lot of good for production and consumption from the global economy, due to the largely global integration of the Indian economy. The prices of the tradable items have also risen due to exchange rate depreciation.

The depreciation of the Indian currency rupee helps Indian exporters which are largely engaged in labor intensive business and high tech services. Due to very fragile developed economies, exporters are directly affected. The decrease in demand from the developed economies must have caused financial stress on the exporters but currency depreciation would have marginally offset the pain to them. In 2009, RBI had intervened into the forex market to maintain the edge of the exporters by limiting the rupee appreciation.

The RBI has played a very important role in forex market by regulating the participant but limited its direct intervention in the market. Last time, RBI intervened in forex market in 2009 by supplying rupee liquidity to limit the rupee depreciation and save Indian exporters.

 RBI has a foreign exchange reserve of $ 250 billion, which is very limited compared to size of the economy and forex market. RBI intervention cause very little impact in the market while depleting its reserve. Also, the uncertain global economy requires RBI to be more cautious and save its fire for the future time, in which Europe market is expecting some more damaging events in case of sovereign default by any nation.