The rupee plunged to an all-time low of 38.85 yesterday morning following media reports that the Union finance ministry and the Reserve Bank (RBI) had decided on an intervention band of five per cent around the Rs 38.4 which is the real effective exchange rate (REER). The RBI denied these reports. The Indian unit finally closed at 38.56-61 after volatile trade.
Forward rupee also came under pressure as demand for forward dollars shot up. The six month premium closed at 6.58 per cent and the 12 month at 6.5 per cent as against Thursdays close of 6.07 per cent and 6.04 per cent.
The reports about an intervention band turned the market jittery as a five per cent intervention limit suggested that the central bank which has been observed to be rather slack in its intervention could allow the rupee to depreciate further.
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After opening at 38.70-80, the rupee almost immediately shot up to 38.85. RBI quickly went into action by flashing a denial of the newspaper reports. An RBI official told Reuters that newspaper reports suggesting the government was planning an exchange rate band for the Indian rupee had no official basis.
The market reacted strongly to the reports as the RBI has not been very aggressive with its intervention despite the rupees free fall from 36.30 to 38.85 within just a month.
This led the market to believe that the central bank probably wanted a soft-landing of the rupee to levels closer to what it perceived to be the REER. Hence, news of the REER being fixed at 38.4 plus a five per cent band around the REER led to fears that the RBI would not prevent a further depreciation of the rupee from the present level unless this limit was crossed.
Hence, both banks and corporates started bidding for the dollar aggressively for various maturities in the spot and forward market pushing the rupee up to 38.85 within half-an-hour of trade.
The RBI also intervened by selling spot dollars in the morning. The rupee recovered to 38.40-45. However, this recovery was temporary as corporate demand picked up once again putting pressure on the Indian currency bringing it down to 38.61-64. Another round of intervention pulled rupee up to close at 38.54-61.
As the spot rupee weakened, premiums on the forward dollar climbed sharply on hectic buying for various maturities. However, RBI did not intervene in the forward segment.
Premiums which were softening over the last few days hardened again yesterday by 10 paise for six months to 18 paise for 12 months. May closed at 125-127 paise as against Thursdays close of 111-117 paise. November closed at 248-251 paise, as against Thursdays close of 228-233 paise.
Banks are rather surprised at the RBIs feeble intervention attempts. However, the RBI has indicated that it would not like to use up its forex reserves merely to feed speculation but instead would buy or sell based on the genuine needs of the market.. Instead the RBI has preferred to crackdown on speculation as it feels much of the movement is a result of speculation.