 "Rajan's breathing exercise fails to pacify the rupee")
Raghuram Rajan tried to pacify currency markets by giving yoga lessons on deep breathing in his statement where he said that there is no fundamental reason for volatility in the value of rupee. He said that we are left with fears about what others will fear and do in a particular situation. He advised that at such times, it makes sense to take a deep breath and examine the fundamentals.
The markets followed suit and practised some breathing exercises in the first few hours when the rupee opened at 62.95 compared to previous day's close of 63.32. But then there was a wake-up call in the form of WPI inflation numbers which touched a 8 month high of 7 per cent. Rhythmic breathing session got over, rupee jumped to touch a high of 63.28 and is presently trading at 63.21 against the dollar.
Irrespective of the rupee movement, Rajan needs to be complemented for making a statement in order to pacify the markets and explain the facts of the case.
Part of the reason for high volatility in the currency market was on news of oil marketing companies again entering the market for their dollar purchase. But Rajan says that this has been happening since October 14, 2013 and markets have taken note of it only after some talks by the finance ministry.
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But the market's reaction was natural.How else will a market react when they find the biggest buyer is amongst them. It would try to raise the bar and earn their pound of flesh before accommodating the oil marketing companies. It's like every time market comes to know Rakesh JhunJhunwala is buying a share, everyone rushes to buy it before him.
Another reason for the rupee volatility was the debt outflow and how much of the current account deficit will be funded by FII inflows. Rajan has explained that even if the remaining FII debt leaves the country, it will not have much of an impact as current account deficit is expected to come down by $32 billion and there has been further inflow of $18 billion through the swap mechanism announced by him at the start of his tenure.
Two observations here, first the inflow of FII money through the swap mechanism is time bound and will expire by November 2013 and secondly, most of the CAD reduction is on account of strangulating gold imports. Despite the sharp drop in gold imports, there has been no supply disruption on the ground. This only means that gold is being smuggled in through various routes. Rajan acknowledges the smuggling part but considers it too small to be worried about.
Gold jewellery manufacturers on the other hand feel that given the difference in the official price and the street price (difference of 6-7 per cent) and no supply problem is a clear indication of the scale of imports taking place. Loss to the economy of goods entering and leaving the country without being appropriated for is much bigger. Curbs on gold imports can only be a temporary phenomenon, with import duty reduction and changes in the restrictive import policy rules, the number is expected to rise again.
Rajan has taken comfort in the sharp growth in exports and reduction in imports. But both are an outcome of the sharp drop in the value of rupee. In any case, reduction in imports is a sign of growing weakness of the economy.
Rajan in his statement is not building a case for strengthening the rupee, which would harm exports. Rather, he wants volatility to be curbed. In his statement he has said that markets need to worry about the right thing and not the wrong ones. Thus the breathing analogy, which would cool nerves.
But the real cooling of nerves came from Janet Yellen, nominee to the chair of Federal Reserve when she signalled that tapering is not a priority as the US central bank has more work to do to help economy and labour condition. Globally, markets moved up on this statement and India too joined them.
We will take Rajan's advice on deep breathing provided we are asked not to examine the fundamentals because that increases the heart rate.