Rupee Weakens amidst Rising Concerns about India’s Economy

on Aug 2, 2012
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On 31 July 2012, Reuters reported that India’s rupee weakened while the country’s central bank kept interest rates intact, depriving the economy of near-term drivers to boost growth.

The rupee closed at 55.6450/6550 per US dollar, marginally weaker than its close of 55.5850/5950 on July 30. In addition, India’s currency closed down 0.1 percent for the month of July against the greenback.
The Reserve Bank of India (RBI) left interest rates unchanged, demonstrating that bringing down inflation was the top priority despite the deteriorating economic conditions. According to a Financial Times article, the RBI kept the repo rate, or the rate at which it lends to commercial banks, at 8 percent. The RBI raised its inflation forecast for the coming year to 7 percent from 6.5 percent, and revised its growth projection for the current year, lowering it to 6.5 percent from a previous 7.3 percent.

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!m[](/uploads/story/222/thumbs/pic1_inline.png)Bloomberg reports that the RBI also reduced the statutory liquidity ratio (SLR) from 24 to 23 percent, with the measure coming into force on August 11. SLR is the percentage of deposits which banks in India must keep invested in government bonds and other approved securities. As noted in the FT article, analysts expect that even though the SLR cut may serve to boost liquidity in the short-term, it is unlikely to have a wide-reaching effect on the markets.

And while India’s central bank failed to deliver the cut in borrowing rates which markets had hoped for, it also separately stated that it was going to allow companies to keep all of their foreign exchange earnings while also easing restrictions on forwards contracts. According to Reuters, the actions reverse two regulations passed during periods of intense rupee volatility, and traders interpret the RBI’s statement as an indication of the central bank’s improved confidence that the worst may be over for the rupee in that regard.

Curbing inflation remains RBI’s primary objective, with the FT quoting Duvvuri Subbarao, head of the RBI, who pointed out that in the current circumstances, lowering policy rates would “only aggravate inflationary impulses without necessarily stimulating growth.”
According to Reuters, the focus is now shifting to India’s government, which is expected to step in with fiscal reforms and measures, aimed at attracting foreign investment, which will be crucial for sustaining the rupee’s rebounds from the record lows observed in June. Investors, however, seem to be losing confidence with the government facing policy disagreements among its coalition allies.

The other factor threatening India’s expansion is the weaker-than-expected rainfall during the monsoon reason. According to Bloomberg, the monsoon which normally accounts for more than 70 percent of India’s annual rainfall is some 20 percent below normal for the two months ending July 31. The scanty monsoon rains are likely to spur inflation by boosting food prices.
And while domestic factors such as growth slowdown, infrastructure problems and higher food costs put pressure on the rupee, Reuters notes that in the near-term India’s currency is likely to be driven by global risk factors in a week in which investors hope that the European Central Bank or the US Federal Reserve will announce further monetary stimulus measures at their respective policy meetings.

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