Tuesday, May 08, 2007

Up Up and Up.....

Re edges toward 9 yr peak.... Rs. 40.88

Read Here

The rupee has gained more than 8% ths year, with most of the gains coming in the last 2 months.... boosted by capital inflows into the fast-growing economy.

Foreign funds hav bought more than $2.9 billion worth of stocks so far in 2007. And... the central bank bought $19.7 billion in the 4 months to end-February in a bid to stem the rupee's rise..... ths lead to infusion of rupee, which increades liquidity and ultimately lead to rise in inflation.


One of the prime domestic reasons for the sharp appreciation in the domestic currency is the tight liquidity in the money market. The shock therapy applied by the RBI to cool down inflation has choked liquidity further.

RBI increased the cash reserve ratio (CRR) by 50 basis points (bps) [100 bps make 1%] to 6.50%.... nd repo rates by 25 bps to 7.75% to control inflation [CRR is the proportion of deposits that commercial banks need to keep with RBI as cash...... nd the repo rate is the rate at which banks borrow from RBI for the short term]. Now... these measures absorbed Rs 15000 crore from the banking system.

Also.. the main cause for rupee's appreciation is Excess dollars chasing the economic boom in India.

Try to offer to exchange US dollars for Indian rupee... a person who is aware of market trends... wld probably decline the offer..... Re has lot of importance in the forex martkets. It has appreciated to an 9 yr. high against the $.

Improving economic fundamentals.... nd stronger growth prospects hav led to a global interest in the Indian economy. Foreign money is pouring in... to ride the economic boom nd take advantage of the rising interest rates.... stock nd real estate prices.

Can u imagine.... the net FII inflow (debt and equity) since Jan, 2006 was close to $10 billion. NRIs also remitted home a considerable amount of dollars. The higher intt. rates in the domestic mrkt..... compelled companies to borrow in dollars in foreign mrkts (u can say external commercial borrowings) to fund their expansions plans...... Naturally, when the supply of dollars exceeded the demand, the rupee soared...

FIIs usually get money in India in dollars to invest in stocks and other assets. A stronger re will mean tht..... they get a lower amount to invest. A rising re will add to the dollar returns of FIIs that don't hedge the currency risk. In order to prevent a rapid appreciation of the rupe, the RBI buys dollars from banks and sells rupees, which enhances the liquidity in the banking system.

If ths liquidity is not sterilised (absorbed).... out of the banking system by the RBI..... interest rates are likely to fall. These excess dollars usually find their way to the country's foreign exch. reserves. The RBI and the government incur costs on account of the sterilisation measures and maintenance of reserves.

Higher reserves can be helpful in the event of an external financial crisis, like the foreign exch. crisis in India in 1991.

The long-term intrinsic value of a currency is a function of various other factors, such as int. rate differentials.... trade equations..... and so on. It shlld always be kept in mind tht.... the rupee has appreciated primarily on account of the excess dollars chasing the economic boom in India.

And yes.... Any reversal of such flows.... due to a change in the global perception of India cld put the rupee under pressure.

Now, The RBI is facing a dilemma whether to control inflation..... or.... manage the re to maintain the country’s export competitiveness. If the central bank decides to maintain the rupe weak.... it wld end up generating more liquidity in the domestic mrkt.... which wld fuel inflation. With inflation ruling at above 6% compared with a comfortable 5% to 5.5% level envisaged by the central bank..... controlling inflation seems to be the priority.... :)

Whew.... dont knw wht concrete steps shld be taken at ths point of time... It again like... ????? :) :)

I hope i hav clarified some imp. points.... ok thn... feeling too hungry... see u later.. :)


Prakash Venkat said...

Do u mind explaining a bit more for lay man like me ... How is liquidity coming into picture ???

Urvi said...

Oh ok... lemme put it in detail.. updates coming up shortly.. :)

Prakash Venkat said...

Thanks a lot for the update ... But still I have lots of doubts .....:) But I get the importane now ... :)