Will the RBI's Intervention Succeed? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 12 May 2012
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Will the RBI's Intervention Succeed? A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
The rupee has been under significant pressure recently. It is nearing record lows against the dollar. We cite all sorts of problems including high inflation, a worsening current account deficit, a negative investment sentiment, corruption slowing down the economy, etc. All of these are good reasons to explain the rupee's fall. So what do we do now? How do we make the rupee a stronger currency?

One way would be to try and fix the problems described above. We could take measures to reduce inflation, improve our current account balance, reduce corruption, and increase growth. Investor sentiment will automatically improve if these fixes take place. Surely, tackling the root cause of the problem is the most sensible way to fix it.

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But instead, we do the one thing that time and time again never works. We intervene to prop up the currency. During the week, the RBI stepped in to the currency market to increase the value of the rupee. Sure, worked on the day. The rupee had a large rise against all its traded counterparts, just like we want.

But what about tomorrow, the next day, and the day after that? Every time we intervene in the currency market, we have to draw from our foreign exchange reserves. The more often we do this, the worse off we will be in the long run. On top of that, interventions rarely work beyond the short term. Consider the Bank of Japan that has repeatedly stepped into the currency market to weaken the yen over the last two years. Despite their best efforts, the yen is near its all-time high against the dollar and the rupee.

On top of the currency intervention, the RBI has also ordered a host of measures to prop up the rupee. One such measure included requiring exporters to sell a portion of their currency holdings. This action has resulted in a significant amount of inflows, but once again, it is another measure that will only work for short term relief. It does nothing to solve the underlying problem.

On top of the fact that currency interventions are useless in the long term, they also create another problem. The RBI's intervention creates a sense of fear and panic. It is a signal that there must be great underlying weakness in the currency if the central bank needs to intervene itself or tell other institutions to prop up the currency. Whether this is true or not, investors will react negatively and the rupee will suffer more in the short term.

To solve the problem, the best thing we can do is take concrete steps to fix the underlying issues that we mentioned at the start of this article. Currency falls are mostly an issue of confidence, so as long as the underlying issues are getting solved over time, and people believe this is the case, then the rupee should be just fine.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

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10 Responses to "Will the RBI's Intervention Succeed?"

AJ

May 15, 2012

this is bailout age and in the history the future generation will learn how the lazy grasshopper enjoy the cake by having it and eating it. everyone want instant solutions and why one should think beyond today. who knows whether tomorrow comes or not.

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kalabairava

May 14, 2012

The currency problem is mostly because of RBI's inaction to curtail black money and fake notes.

When all countries are freely printing our Rs. 1000 and Rs. 500 notes and using it to support terrorism, the RBI is a sitting duck instead of devaluing the high value notes. As a sweet bonus black money and illegal money is washed away.

All persons who have legal high value notes may be please asked to deposit within 10 days and the rest of them can face the music.

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VIJI

May 14, 2012

BLACK MONEY GOES OUT AS FLIGHT OF CAPITAL &RETURNS AS WHITE AND ENJOYS HIGH VALUE EBTRY WHEN R's DEPRICIATION AND LEAVES OUT WHEN APPRICITION (SILENT SPECTATORS) NOT A MAJOR ROOT CAUSE ?

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Jeyaraman

May 13, 2012

Mr.Asad, I agree with your view. Because, RBI is consistently interfering in FX market with some active measures, but the bullets are becoming powerless due to the weak fundamentals. Nowadays, people involve in trading more than concentrating on manufacturing. Also, weak rupee is good when the global economy is booming. But the scenario here is not the case. The Global economy is itself in slow pace. We really don't know how much ammunition does the RBI have to tackle the fall of rupee. In short term rupee is expected to be under pressure against its counterparts, could even weaken more.

- I'm an analyst in Forex market.

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Kuldeep

May 13, 2012

Nothing will ever work till the scourge of black money is eliminated and the justice system is overhauled with due urgency to speed up justice.

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Varadhan

May 13, 2012

That is what is happening in India .Is it not the Central Government responsibility to handle these underlying issues?As the CG is acting as the silent spectator ,RBI applies all the limited tools available at their end to control.These are only temporary solutions only .Election of this Manmohan Singh Government is an historic blunder of India.Definitely ,leaders like Pranab would not have been insensible to issues like Manmohan Singh.Sheer greed for power.

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C K VAIDYA

May 13, 2012

RBI is certainly conscious of limitations to its interventions in Forex market. However, it considers fluctuations in forex rates as undesirable and harmful and therefore intevenes to ensure there is no runaway depreciation or appreciation.
As regards the exporters being required to convert the forex into rupees, I think RBI's stand is that this account is not yo be used for speculation.

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Vivek Kumar

May 13, 2012

Reading the Ten Commandments to the government or central bank is obvoius but easy thing to do, your readers would expect better analysis than this! Lets not forget that we donot live in an utopian world and rationality, at the superficial one, is not how to understand situation. Please come up with something more.

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STHITHAPRAGNJA

May 13, 2012

""Surely, tackling the root cause of the problem is the most sensible way to fix it.""

Asad DOSSANI (AD) Ji,

With all humility fortified with
Abundant ignorance I am prompted
To observe as under::

I am citing a real-life instance
which seems similar to the position
of the Indian currency against the US$:

A FRIEND OF MINE HAD SOME RASHES ON HIS HANDS WHICH WAS NOT HEALING
FOR SOMETIME.
He therefore decided to take specialist treatment for the same in a metropolitan city.

FIRST he went to a Skin(Dermatology)specialist
Who referred him to a Neuro-surgeon
who in-turn referred him to a
GENERAL PHYSICIAN !!

After ALL THESE (FIRST ROUND OF RUNNIG AROUND & CONSULTATIOINS)
WHEN HE WENT to the SKIN SPECIALIST
HE WAS TOLD THAT ALL OF THEM ( THE GENERALIST+SPEIALISTS) WILL MEET TO DECIDE THE EXACT
NATURE OF THE DISEASE FROM WHICH HE WAS SUFFERING (TO BE FINALLY DIAGNOSED) SO THAT
THE EXACT NATURE OF CURATIVE TREATMENT COULD BE DECIDED UPON??

I am whole-heartedly concurring with your statement(very well stated!!)
“”Surely,TACKLING THE ROOT Cause OF THE PROBLEM
IS THE MOST SENSIBLE WAY TO FIX IT??””

IF MY FRIEND HAD READ YOUR ARTICLE (A FEW DECADES AGO--??) HE COULD HAVE AS WELL MADE POROFOUND USE OF IT BY CITING IT TO THE MEDICAL SPECIALISTS whom he had to consult??

I hasten to conclude AD Ji !!

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Ravi Johar

May 12, 2012

Alas! If only it was that easy to fix root causes. We will not need Anna Hazare or Lokpal or efforts to boost competitiveness (which takes years to build on). All that is not going to happen this year or in 2014 and probably not by 2020 !

The only reason investors consider India is because of growth rates of economy and because the rest of the world is in a bigger economic mess. Change both these against us and nifty will hit 4000 soon. Fortunately Europe might save us because they wont get their act together for a while. But dont count on Asia to blunder through beyond next 12 months. Hence our window is relatively short.

That is the clear downside one must be mindful of over next five years.

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