Rising inflation may force RBI to relook at rupee

There could be only one way for the rate of inflation that climbed to 6.52 per cent for the week ended July 9 unless the Reserve Bank of India (RBI) changes its strategy for the foreign exchange market, senior bankers said.

The rupee touched its one year low of 46.26 against the dollar on Friday.

With the appreciating dollar, the inflation rate is bound to rise as the cost of import is going up in rupee term. As the global crude price is veering around $41 per barrel, the pressure on the domestic inflation rate will be enormous unless the RBI changes its policy and starts intervening in the foreign exchange market to stem the fall of the rupee, bankers said.

Despite the hike in international commodity and energy prices, a stronger rupee will bring down the import bill. Both the RBI and the finance ministry are looking into the matter closely.

About 70 per cent of the country's oil requirement is met through imports and between 30 and 40 per cent of the country's $7 billion monthly import bill is on account of oil. For every Re 1 rise in petrol/diesel, the impact on the inflation index is to the tune of about 16 basis points (one basis point is one hundredth of a percentage point).

"With over $120 billion foreign exchange reserves in its kitty, the central bank can certainly intervene in the market to stem the fall of the rupee. If not, the inflation rate can only inch up," said another banker.

The financial community also felt that an appreciating rupee will not impact the country's exports. Last year, the rupee appreciated around 9 per cent against the dollar "" its highest annual gain "" when the exports grew by around 20 per cent. The growth of merchandise exports was over $60 billion and software by about $12 billion.

The rupee, which breached the 44 level to touch 43.75 in March end, gained further strength in the first half of April and touched a high of 43.50 against the dollar on intra-day trade on April 8. Since then it has depreciated by close to 7 per cent.

The recovery of dollar, which was depreciating against all major currencies across the world till recently, is now a global phenomenon. Indian importers did not hedge their positions over the last two years as the outlook on the rupee was bullish. However, they are rushing for the cover now.

This has put pressure on forward premiums with the six-month annualised premiums veering around 2 per cent. Till recently, forward dollars were sold at a discount. With the dollar gaining strength, the arbitrage inflows have stopped as the greenback has started attracting investment.

The RBI's foreign exchange policy is to allow a market-driven exchange rate and it did not have a target for the rupee. Officially, the "exchange rate is based on demand and supply and all we try to do is to ensure that there is not much volatility."

In the last week of March, the RBI stayed away from the market when the value of the rupee vis-...-vis dollar was going up on the back of dollar inflow.

The RBI could not intervene as the stock of government securities in its kitty was not enough to continue with its dollar mop-up (sterilisation) exercise.

Besides, by allowing the rupee to appreciate, the RBI also tried to limit the cost-push inflation through its impact on imported prices.