RBI has managed exchange rate well

The Indian rupee has depreciated by more than eight per cent so far this month, after remaining stable for a fairly long period. Naturally, there has been a growing pressure on the Reserve Bank of India (RBI) to aggressively intervene in the forex market to stem the rupee's decline, since imported inflation rises and risks associated with exchange rate volatility are growing.

Despite the rupee falling to its lowest level against the dollar in more than two years on Thursday, RBI has stayed on the sidelines, stating it would intervene aggressively only when it saw excessive volatility. Many experts feel this stance of RBI's would aggravate the uncertainty in equity markets and scare foreign investors away.

However, as a central monetary authority, RBI has to focus on the effectiveness of forex interventions. We cannot forget such interventions do involve important costs. Among others, these costs are the risks of financial losses on the operations, the cost in terms of resources devoted to the conduct of these operations, and the cost in terms of credibility, if the intervention fails to deliver the desired effect.

The considerations of the costs versus gains of intervention might have prevented RBI from intervening aggressively, though there has been some intervention in the market, as reported by some of the newswires.

While the current attack on the rupee is primarily sentiment-driven, on account of the growing turbulence in Europe, the rupee has developed a strong depreciation bias, due to India's widening current account deficit and growing dependence on short-term flows. These factors may not allow our currency to recover substantially (and sustainably), even after RBI intervenes aggressively. Also, according to RBI's report on forex reserves in August, India's external liabilities are more than its external assets. So, RBI would like to use forex reserves more prudently. Besides, a depreciation bias would help exports and employment generation, which is the need of the hour.

We also need to understand central banks the world over prefer selective, rather than complete, public disclosure of their interventions to make such moves more effective.

Rupa Rege Nitsure
Chief Economist, Bank of Baroda