It’s a result of incomplete deregulation. The last two or three years saw an excessive supply of dollars, but the RBI was sucking it up. It obviously couldn’t last forever, though people were content to believe it would.
What happened was that in June and July, there was growing demand for dollars but no supply. Exporters were taking toward premia and selling dollars. The rupee started weakening.
Firstly, importers needed dollars, which put a strain on the rupee. Then, sometime in August or September, Indian Oil needed roughly $200 million and they went on a buying spree from different banks. The banks in turn purchased dollars to cover their positions and stay within RBI stipulated norms. Since the rupee market is very think and cannot absorb very large transactions, this had a multiplier effect. The rupee slid enormously and the market practically blew up in our face.
What effect will this sudden slide of the rupee have on the Indian economy?
It certainly won’t be good for the economy. It’s not benefiting anybody, the sensex is down and imports have become horrendously expensive. Exporters would be quite content with the rupee at 32 to the dollars.
What should be done to arrest the slide?
The RBI should come in aggressively. As of today (October 26), they have spent only about $200 million. I think they will need to spend upward of $1 billion if they want to contain the rupee. Otherwise the Rs 40 to a dollar level might be crossed. In a market like this, the RBI cannot afford to just sit back and watch. Thank God for the Diwali holidays, otherwise the rupee would have slid even more drastically by now.
