Why the Reserve Bank of India is on a dollar buying spree (Economy Business Line )

The Reserve Bank of India is on a dollar buying spree. Its net purchase of dollars in the spot market in the first four months of 2015 totalled $33.1 billion. This is close to the dollar purchases of $34 billion in all the 12 months of 2014. The purchases between January and April this year are also three times the net purchases during the corresponding period in 2014.
When the central bank buys dollars in the forex market, it results in the rupee weakening. The dollar purchases in the first few months of this year suggest the RBI doesn’t mind the rupee depreciating against the dollar.
The RBI has also been intervening through the rupee forward market; outstanding forward purchase contracts towards the end of April 2015 stood at $5.2 billion.
Boosting reserves

Why is the RBI buying dollars at this pace? According to market experts, the primary motive appears to be to boost reserves.
“The RBI has absorbed almost the entire $50 billion of foreign portfolio inflows received in FY 15, expanding forex reserves to almost $350 billion,” says Ritesh Jain, Chief Investment Manager, Tata Asset Management.
“This helps in increasing the import cover to the RBI’s comfort zone of around 9 to 10 months. This provides a buffer in the event of a large upward move in energy prices.”
Another reason for the RBI’s urgency in bolstering reserves could be the impending hike in interest rates in the US. This could see an exodus from the bond market, destabilising the forex market.
Controlling appreciation

The other objective behind the sustained dollar buying could be to maintain currency stability. The rupee has been among the out-performers among the emerging market currencies so far this year, losing just 1.25 per cent against the dollar. In contrast, other emerging market currencies such as the South African rand, Indonesian rupiah and the Brazilian real have lost between 6 and 15 per cent against the greenback. “The RBI has done a good job of keeping the rupee in a controlled range and not letting it appreciate rapidly in a softening import and rising fund flow environment,” says Jain.
Experts believe that the significant out-performance of the rupee is an outcome of better macros, relative to other countries.
“I see no reason for any kind of underperformance of the Indian currency vis-a-vis other currencies over next two to three years,” says Amit Tripathi, CIO, fixed income investments, Reliance Capital Asset Management.
The 36-country based Real Effective Exchange Rate of the rupee, which was at 111.7 at the end of April, also points towards over-valuation of the rupee when compared with the currencies of our major trading partners. This metric could also be giving the central bank the room to buy dollars.
The RBI’s purchase of dollars has an inflationary impact on the economy. How is the apex bank controlling that? “The RBI has not let the rupee go uncontrolled — in terms of higher money supply,” says Jain. “It has been selling rupee bonds to balance the printing of money, the last one being towards the end of May 2015. We may see some limited impact of inflation as a consequence.”
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