Source of Article..... Mumbai: The landscape for the rupee appears to have shifted, with the once remote 40-per-dollar level suddenly within reach as the Reserve Bank of India (RBI) takes a more hands-off approach to its currency and to two-way capital flows. Analysts say a decision by the central bank last week, to allow more overseas investment by companies and mutual funds, was a pragmatic response to strong capital inflows that are pushing up the rupee and making it harder and harder to control. On the rise: The rupee is rising beyond the 43-47 per dollar range it has maintained over the past three years On the rise: The rupee is rising beyond the 43-47 per dollar range it has maintained over the past three years The partially convertible currency is just over a rupee away from 40 per dollar, a level unseen since 1998. Analysts expect that level to be hit during the year before weakening as the central bank steps to check its appreciation. The day-before-yesterday's volatility is today's flexibility," RBI governor Y.V. Reddy said after making an annual policy presentation last week. The reason for the central bank's more relaxed attitude towards the rupee appears to be threefold. Firstly, a rising rupee can act to combat inflation, which has prompted five interest-rate increases in under a year. Secondly, central bank currency intervention to try to control the rupee has fuelled money supply, and by extension inflation. Thirdly, the central bank is warming the market up for convertibility where capital flows in and out of the country will be given a much freer rein. Reddy himself argues that letting the rupee rise is less about inflationholding stubbornly above 6%than capital account convertibility, a goal for 2011. Han-sia Yeo, strategist at Bank of America in Singapore, and others say a firmer currency would help at the margins to curb price pressures, especially as the central bank fears raising interest rates could lure yet more foreign capital. It was a reluctant policy change," said Shahab Jalinoos at ABN Amro in Singapore. I don't think it was one they necessarily planned for. It was imposed on them by the reality of capital flows." The central bank says it intervenes to smooth volatility, and for the past three years it has kept the rupee in a 43-47 per dollar range. Heavy direct and portfolio investment into the fast-growing economy have prompted the central bank to sell rupees for dollars to protect exports and temper exchange rate turbulence in case of a sudden reversal of flows. Foreign direct investment into India touched $16 billion (Rs65,600 crore) in 2006/07 versus $5.5 billion in 2005/06. In addition domestic firms have exploited lower interest rates overseas, to raise about Rs48,300 crore in debt between April and December, up 77% from the same period a year before. After buying dollars from November to March, when reserves climbed $30 billion to $200 billion, the central bank allowed the rupee to touch a nine-year peak of 40.60 per dollar last week. Analysts polled last week forecast that the rupee would peak at 40 per dollar before ending December at 42.40, 4.4% up on the year. Yeo said the central bank's new tolerance was driven by limits on its ability to keep pumping rupees into the market to temper the currency's rise. To stop those rupees fuelling inflation, it has drained them from the financial system by raising the amount of cash commercial banks need to keep in reserve and by selling special intervention bonds. But analysts say that route is increasingly expensive. Interest rates on intervention bonds are rising, and in any case seeking to control a currency while setting higher domestic interest rates creates policy dilemmas. Other analysts say the central bank could resume intervening later this year once inflation has stabilised near its comfort zone of close to 5%. We expect RBI to come to a more aggressive appreciation-fighting mood when the first signs of a decrease of inflation become clearer," Sebastien Barbe, senior economist at Calyon, said in a note. Given the intervention problems, analysts say the central bank also lifted some curbs on capital outflows to try to counteract capital flowing into the economy. Reddy called it a step towards greater capital account convertibility. These are the slew of measures which are part of capital account liberalization and partly preparing the domestic industry to handle the currency fluctuations better," he said. Article Publish by:www.investmentbankingcentral.com
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