The central bank has a real problem on hand…
Source: Trading Economics
For the first time during this year, the forex reserves of RBI fell below the $400 billion mark. This is a sharp fall from the levels of $427 billion at the beginning of this fiscal. So how did the dollars deplete so rapidly?
Defending the rupee…
The simple reason why the dollar reserves have fallen is the RBI attempt to aggressively defend the rupee at around the 69/$ mark. It did manage to do it successfully for a few weeks. However, the Turkish Lira crisis led to a sharp rise in demand for dollars from importers and banks leading to the INR cracking beyond the 70/$ mark. The RBI has already expended $27 billion trying to defend the rupee without much avail. Hence the central bank may not be too keen on that. It is not just about rupee pressure, but there are also other factors why the RBI cannot allow the reserves to go much lower from here. And, macros are only worsening!
It is all about trade deficit
The trade deficit at $18 billion in July was a real shocker. But the bigger worry is that imports now look set to cross the $550 billion mark this year. That means at current levels, the forex chest covers less than 9 months of imports. With rising oil import bill, that is a worrying situation for the RBI. Unless the NRI bond scheme goes through, the RBI may not be too keen to push its luck on the forex reserves much further.
What are the options?
From a macro point of view, it really is becoming a conundrum for the RBI. Even with an NRI bond issue it will just about cover the lost ground. What after that? The only option with the RBI now would be to let rep[o rates rise further from here. That would absorb part of the impact and invite aggressive foreign flows. That would be a quicker way to stem the fall in the rupee!