A former governor of the Reserve Bank of India (RBI) once told me that in a “moment of crisis the central bank can’t be seen to be doing nothing” even if “do nothing” might be the best strategy to follow.
This might well be the spur behind the RBI’s recent defence of the rupee. It started its defence when the currency first closed in on the 60 per dollar mark, by selling dollars.
But selling dollars couldn’t go on indefinitely. India’s foreign exchange reserves are around $280 billion – equal to around six-and-a-half months’ imports. Such low levels of forex reserves haven’t been seen since the 1990s.
Then the central bank tried to squeeze out rupee liquidity by severely limiting the amount of money that banks could borrow from it at the repo rate, or the rate at which the RBI lends to banks, now at 7.25%.
Banks are now allowed to borrow only up to 0.5% of their deposits at the repo rate.
Beyond that, they need to borrow at the marginal standing facility rate, which is at 10.25%. That’s 300 basis points (one basis point equals one hundredth of a percentage) higher than the repo rate.
This has started to push up interest rates in general.
Banks are also supposed to maintain an average cash reserve ratio of 99% with the RBI on a daily basis, against the earlier requirement of 70%.
The RBI had hoped that all these moves would squeeze rupee liquidity out of the market and help it gain value against the dollar.
But nothing of that sort happened. On Tuesday, the rupee lost further value to hit an all-time low of 61.81 to the dollar intraday, before recovering to close at 60.81, again, with RBI intervention.
Several economists have now come around to the view that the rupee will continue to lose value against the dollar. Rajeev Malik of CLSA, for one, sees the rupee hitting 65-70 to the dollar by next year.
Given this, the RBI’s intervention can at best postpone the inevitable. But it can’t stop trying, can it?
Albert Edwards of Societe Generale had an interesting analogy. “When there are problems, our instinct is not just to stand there but to do something... When a goalkeeper tries to save a penalty, he almost invariably dives either to the right or the left. He will stay in the centre only 6.3% of the time. However, the penalty taker is just as likely (28.7% of the time) to blast the ball straight in front of him as to hit it to the right or left. Thus goalkeepers, to play the percentages, should stay where they are about a third of the time. They would make more saves,” said in a note earlier this year.
But they rarely do that. “Because it is more embarrassing to stand there and watch the ball hit the back of the net than to do something (such as dive to the right) and watch the ball hit the back of the net,” wrote Edwards.
The RBI is like a football goalkeeper. It knows ‘do nothing’ is the best course, but it can’t just stand pat.
Kaul is a writer.
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