To prevent the rupee from spiralling downwards, the Reserve Bank of India will resort to appropriate measures, including increasing the supply of foreign exchange by expanding market participation and intervening in excessively volatile market conditions, said Dr Subir Gokarn, Deputy Governor.
Underscoring the importance of resisting currency depreciation by increasing the supply of foreign currency by expanding market participation, the Deputy Governor said the RBI has done this by increasing the limit on investment in the Government and corporate debt instruments by foreign investors.
Further, the central bank has also raised the ceilings on interest rates payable on non-resident deposits and the all-in-cost ceiling of external commercial borrowings has been enhanced.
Dr Gokarn's observations come at a time when the rupee has weakened nearly 17 per cent against the dollar since April 2011, making it the worst performing currency in Asia.
Referring to the recent sharp depreciation in the rupee, which led to an assessment in some quarters of ‘helplessness' in dealing with the kind of global turbulence that is being witnessed today, the Deputy Governor said “our strategic behaviour should not be misconstrued as an inability to lean against the wind….
“If we do see the short-term risk of a downward spiral escalating, we will not hesitate to use all available instruments.”
Forex reserves and intervention
Though the country has large reserves (over $300 billion) Dr Gokarn said the RBI's policy approach does not involve strong intervention in the currency market to achieve a specific target rate.
“Not using reserves to prevent currency depreciation poses the risk that the exchange rate will spiral out of control, reinforced by self-fulfilling expectations. On the other hand, using them up in large quantities to prevent depreciation may result in a deterioration of confidence in the economy's ability to meet even its short-term external obligations.
“Since both outcomes are undesirable, the appropriate policy response is to find a balance that avoids either,” he said at a CII Summit.
The RBI's objective is to find a balance between the short-term risk of the rupee spiralling downwards and the medium-term risk of a loss of confidence in the country's ability to meet external obligations.
“We do have the instruments to do this (find the balance) in the form of strategic capital controls, which can be used to enhance the supply of foreign exchange. These will be used as appropriate, with the goal of ensuring that the availability of foreign exchange does not become a de-stabilising constraint,” Dr Gokarn emphasised.