Measures taken by RBI to address Exchange Rate Volatility

The market perception of likely tapering of US Quantitative Easing has triggered outflows of portfolio investment, particularly from the debt segment. Consequently, the Rupee has depreciated markedly in the last six weeks. Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals. The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the Rupee in part because of the improving domestic liquidity situation.

Against this backdrop, and the need to restore stability to the foreign exchange market, the following measures are announced:

1. The Marginal Standing Facility (MSF) rate is recalibrated with immediate effect to be 300 basis points above the policy repo rate under the Liquidity Adjustment Facility (LAF). Consequently, the MSF rate will now be 10.25 per cent.
2. Accordingly, the Bank Rate also stands adjusted to 10.25 per cent with immediate effect.
3. The overall allocation of funds under the LAF will be limited to 1.0 per cent of the Net Demand and Time Liabilities (NDTL) of the banking system, reckoned as Rs.75,000 crore for this purpose. 
4. The overall limit for access to LAF by each individual bank is set at 0.5 per cent of its own NDTL outstanding as on the last Friday of the second preceding fortnight.
5. Currently, banks are allowed to maintain their Cash Reserve Ratio (CRR) prescribed by the RBI on an average daily basis during a reporting fortnight, with a minimum of 70 per cent of the required CRR on a daily basis. Effective from July 27, 2013, banks will be required to maintain a minimum daily CRR balance of 99 per cent of the requirement.

Rupee depreciation

What is causing rupee depreciation?

•          Currency depreciation both on account of global and domestic factors.

•          External Factors: Eurozone uncertainty, Concern  on US stopping fiscal stimulus

•            Domestic factors - current account

-          Demand pressures at home resulting in higher CAD

-          Oil - inelastic demand given absence of pass through

-          Higher imports of gold - as an investment?

•            Domestic factors - capital account

-          Slow down in capital flows since April 2012  (FDI, FII, ECB)

What has RBI done

•          Intervention consistent with our policy

•          Increase in FII limits in G-Sec and Corporate Debt increased by US$ 5 billion each to US$ 15 billion and US$ 20 billion, respectively

•          Increase in all-in-cost ceiling for ECBs

•          Deregulation of interest rates on NRE and NRO accounts in December 2011

•          Increase in ceiling rate on FCNR(B) deposits

•          Deregulation of ceiling rate on export credit

•          ECB raised for Rupee Outlay to be brought in immediately

•          Banned proprietary trading by banks in FX options and futures ( to curb speculation)

•          Asked oil companies to deal with only 1 bank for $ buying needs ( to curb speculation)

2013 vs 1991

1.  Is 2013 going to be a repeat of 1991?

 Basis for this question:

(i)                  1991 crisis triggered by BoP pressures, which in turn were a consequence of fiscal profligacy of the 1980s.

(ii)                Now we are having twin deficits once again

(iii)               Large fiscal and current account deficits are lead indicators of stress building up in the system.

 In 1991, an implosion was imminent. In 2013, an implosion is not imminent. Why?

(i)                  Structure of the economy has changed in fundamental ways. The share of services sector in the economy has increased from 41% in 1991 to 67% in 2012. Performance of the services sector of the economy is less variable than that of agriculture and industry.

(ii)                Today, Indian financial markets are more mature, diverse and deep. Have resilience to absorb shocks.

(iii)               Our regulatory systems and crisis response mechanisms are more robust and sophisticated.

(iv)              In 1991, rupee was overvalued by more than 20%. Today, exchange rate is largely market determined, and therefore able to absorb shocks.

(v)                Foreign exchange reserves are much larger; provide 8 months of import cover as against 2 months of import cover in 1991.

(vi)              External sector vulnerability indicators have deteriorated over the last year, but they are still at safe levels and much better when compared to 1991.