Tags: India | Bank | Economic | Alarm

India’s Central Bank Finally Wakes Up to Economic Alarm

By Ashish Advani   |   Wednesday, 21 Dec 2011 09:04 AM

In my recent travels to India, I was talking to various segments of the population to judge the sentiments of the market.

One resounding comment from all quarters was the lack of action by the Reserve Bank of India (RBI) as the rupee slid more than 15 percent in the past three months.

I have revered the RBI as one of the most sensible central banks in the world. Not only have they shown intestinal fortitude in times of stress, but have resisted the obvious temptations to placate the markets by making inappropriate policy decisions.

So while I could not disagree with the masses who are frustrated with the inaction of the RBI, I was perplexed at the lack of urgency that was shown in stemming the sentiment against the Indian rupee until I saw the recent set of actions that were introduced late last week by the RBI.

There was a growing cacophony by the industry leaders, stock market participants and the self serving politicians who wanted the RBI to intervene in the markets and halt the decline in the rupee.

But the RBI was much too wise to fall for this obvious misstep. History has shown over and over again that intervention by central banks only has limited, short-term effects. And thus intervention to save the rupee would damage the reserves that the RBI had built up.

Dropping interest rates was another misguided, short-term and self-serving demand of the people in India. The RBI once again resisted the demands and stuck to its interest-rate hikes and then orchestrated a pause. As the circumstances have changed, it has now signaled intent toward a stop of hikes with the intent of next moves being determined by trade data.

As you can see, the responses of the RBI are very carefully calibrated and deliberate. There are no knee-jerk reactions as well no caving into special interests. RBI is independent of influence (for the most part) and takes its mandate of staving off inflation very seriously.

Some of the recent actions include opening a separate window which is accessible to oil importers who have to sell rupees to buy dollars.

This eases the selling pressure on rupees in the open markets. The next step it took was to restrict the cancellations of forward contracts and rebooking of the same by corporate hedgers as well as traders. Once again the pressure on rupee sales on the near end of the market is not controlled further.

As a result of this and other actions taken by the RBI, we have begun to see an appreciation of the rupee by nearly 2 percent since the last two working days.

While it is too early to call an end to decline of the rupee, it may be a sign of the bottoming out and as the global sentiment against the U.S. dollar grows again, we could see a rapid appreciation in the rupee.

I would consider an investment in the Indian rupee to take advantage of the upcoming appreciation in the rupee.

But use caution as you jump in as volatility is to be expected and this suggestion of investment is not for the faint hearted.

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