Following the abrupt withdrawal of investments by FIIs in debt funds, the forex market has been very volatile over the last few days. The rupee weakened to a record low of Rs 58.98 to the dollar on June 11. Prior to this, the rupee hovered between Rs 56 and Rs 57. The sudden-spurt in the rupee-dollar exchange rate was due to the demand-supply gap in dollars.

With FIIs unwinding positions in the Indian debt market, there has been a increase in demand for dollars. But due to the shallowness of the forex market, there isn’t a sufficient supply of dollars to meet the demand. After RBI intervention, the rupee-dollar rate has come down to Rs 57 levels as of June 14 – the same as on June 10.

Forex market stability is essential for the orderly development of foreign trade. If the rupee depreciates against the dollar, the prices of imported items, especially petroleum products, will increase, leading to higher inflationary expectations.

If rupee depreciation is on account of weakness in fundamentals, there may not be a case for RBI intervention to prop up the rupee. However, if the exchange rate volatility is on account of the demand-supply gap, the RBI should intervene by selling dollars.

Our exports are less than imports; hence, there is only a net demand for dollars in the market. Banks and forex dealers also keep a very minimum level of foreign exchange. It is only the RBI that is in a position to sell dollars from its forex reserves.

Though the country’s forex reserves are not as high as that of China and some other developing economies, the RBI ought to sell some portion of its reserves in the larger interests of forex market stability in particular, and other markets in general. Price stability is a major concern for the central bank. If the prices rise because of the demand-supply gap in foreign exchange, that will annul the RBI’s efforts to rein in inflation. Utilising some scarce foreign exchange reserves may be justified in order to keep inflation under control.

Countries like Japan have set aside a sizeable amount of dollars as intervention reserves to maintain forex market stability.

Though our reserves of just $287 billion are no match for the $1.8 trillion reserves of Japan, it is essential to keep aside some forex reserves for intervention to deal with undue volatility in the market. The RBI issues bonds under market stabilisation scheme (MSS) when there is a huge inflow of foreign exchange. On similar lines, it is worth considering setting aside ‘intervention reserves’ to stabilise the rupee-dollar rate in the forex market.

Read also: Should RBI defend the rupee? No

(The author is Deputy General Manager, Bank of Maharashtra).

Related Topics
comment COMMENT NOW