For starters, the RBI has asked exporters to translate 50 per cent of their dollar holdings in overseas EEFC (Exchange Earners Foreign Currency) accounts into rupee. Exporters have been given two weeks to do this. The RBI has also stipulated that for all future forex earnings, an exchange earner is eligible to hold only 50 per cent in EEFC accounts as opposed the previous limit of 100 per cent. Traders expect these measures to have a short term positive impact on the rupee as it could lead to an estimated $2.5 billion - $3 billion in dollar inflows from exporters.
The RBI has also asked banks to restrict their net intraday open positions in order to further stem speculation in the markets. The RBI has now set the intra-day open position limit for banks at five times the Net Overnight Open Position Limit available to them or the existing Intra-day open position limit as approved by the Reserve Bank, whichever is higher. However this is unlikely to have a significant impact since speculation in the forex markets has been drastically reduced since the RBI announced curbs late last year.
While these measures have soothed the currency market in near term, the long term view on the rupee remains predominantly bearish. Prominent brokerages like CLSA and UBS still expect it to weaken to levels near 56-57 to the dollar as fundamental and global factors remain stacked against the Rupee.
This begs the question - is the Reserve Bank of India is fighting a losing battle in trying to prevent the Rupee from weakening? Or is the RBI simply doing its job by ensuring that currency market volatility does not hurt the real economy?
If it's the latter, then the RBI's actions are fully justified and well within the stated mandate of the central bank. However if the RBI is trying to prevent Rupee weakness, it is simply delaying the inevitable.
No matter which way you look at it, the rupee seems set for near term weakness. For starters, the global environment is stacked against the rupee. The euro is weakening due to the return of political instability in Greece and the change in leadership in France. For long, it has been argued that the euro needs to weaken further given the weak fundamentals of the Eurozone. The euro seemed to defy that logic and held on to the important level of 1.30/$. Now with economic and political concerns rising, the euro has fallen below 1.30/$. If euro weakness persists and the global risk-off sentiment persists, the Rupee will continue to weaken.
Even at a fundamental level, it has been argued that the rupee could weaken further. India's current account deficit for fiscal 2012 is pegged at near 4 per cent of gross domestic product (GDP). While the government and the RBI have expressed an intention to bring down the current account deficit closer to 3 per cent of GDP in the current fiscal, it remains unclear whether that will be possible. For the current account deficit to ease, the country's oil and gold imports must ease. While oil prices have eased marginally this week, it remains unclear if this decline will continue and whether it will be sustainable. The government is also pinning its hopes on a decline in gold imports. While the changed duty structure should help in this regard, we are yet to see the quantum of decline in gold imports.
Given that high current account deficit, the wide fiscal deficit and the prospect of only a moderate revival in growth in fiscal 2013, a surge of capital flows into India seems unlikely atleast at this stage. This would mean that near term weakness on the rupee seems inevitable despite all the intervention from the RBI and a fall back to all-time lows of 54.30/$ may just be a matter of time.