Top reasons why RBI's measures on the rupee are short-lived

RBI's measures buys time for government to get its act together

Reserve Bank of India’s recent measure to control the rupee seems to have worked, at least for the time being. The sharp fall in the rupee has been arrested with speculators winding up some short positions in futures market. After touching a low of 68.85 against the dollar, rupee presently trades at 67.78. It’s not much of a recovery given the ferocity of the fall, but the fact that at least the measures have arrested the fall for the time being has given everyone some breathing space. 

If the measures were so effective, why did the RBI not use it earlier? To answer this let’s look at the measures announced. 
 

 

RBI will immediately open a forex swap window to meet the daily requirements of the three oil marketing companies (IOC, HPCL and BPCL), the biggest buyers of dollars. RBI will undertake to sell/buy the dollar-rupee swaps for a fixed tenure with the companies through a designated bank. These OMCs have a requirement to the tune of $8-8.5 billion every month, or roughly $400-500 million every day. 
 

Consider a long line in a railway booking counter where most of the people in the line are from a wedding party. What the central bank has done is to open a new window inside its office, for those going to attend the wedding. The benefit of doing this is that as the line will look smaller, anxiety (read volatility) will be lower. 
 

This does not mean that the dollar requirement will cease to exist but it may get met through RBI entering into a currency swap with some trading partners to meet their dollar requirements. India already has a currency swap agreement with Japan for around $15 billion, but this is clearly not enough. 

Now currency swaps require squaring off the position by repaying back in the same currency. In other words, RBI will have to repay the dollars back on a future date. Where will RBI get these dollars? The central bank has asked the OMCs to repay the dollars which will be given through the special window.
 

Here is where the problem lies. As of FY13, collective exports of these three OMCs are Rs 43,431 crore, which on an exchange rate of 68 is equivalent to around $6.4 billion. Against this, the three OMCs imports stood at Rs 407,021 crore or $59.85 billion. Thus their net import stood at around $53.5 billion. Where will these OMCs get the dollars to repay RBI? The only place to do so is to borrow from the market which in our railway counter parlance would mean the wedding party is back in the line once again, thought at a later date.
 

The RBI measures have only managed to buy some time for the government to act and stop pretending by announcing 10 point programmes. The rupee might have just taken a pause on its way down, but to RBI’s credit, it has taken the wind out of the fall.