RBI remains net buyer of greenback in September, snaps up $1.3 billion

RBI remains net buyer of greenback in September, snaps up $1.3 billion

Context

• The Reserve Bank of India (RBI) continues to remain the net purchaser of the U.S. currency after it bought $1.259 billion in September from the spot market.

The exchange business

• In September, RBI bought $3.788 billion, while it sold $2.529 billion in the spot market.
• In August too, the central bank was net purchaser of 3.226 billion of the greenback, buying $4.556 billion and selling $1.330 billion in the spot market.

Why does RBI intervene in the foreign market?

• The RBI intervenes in the foreign market to contain volatility in the rupee and not set a price band.
• In FY17, RBI had a net purchase of 12.351 billion of the U.S. currency as it bought $71.764 billion and sold $59.413 billion in the spot market.
• The RBI has been intervening in the currency markets because a weaker currency pushes up the country’s import bill – you pay more rupees for the same amount of dollars – and contributes to the current account deficit.
• It is also indicative of a country’s economic health and a weaker currency is a signal to investors that the economy is not being well-managed.
• India has a huge import bill largely because it buys almost 80 per cent of its oil from abroad, and a weak rupee can wreak havoc with the government’s finances.
• Market decides the value of the rupee and the central bank only intervene to halt volatile currency movements caused by speculative trades.

What are dollar sales?

• The RBI has been intervening in the forex market since December 2011, when the rupee hit a record low, to stabilize the currency.
• Over the past couple of weeks, it has stepped up its dollar sales to stem the rupee’s slide.

What is the impact of the intervention?

• The reason that the rupee has continued to fall is because the RBI is caught in a cycle where it has to battle inflation, liquidity crunch and a falling rupee at the same time.
• Unfortunately, any action it takes to tackle one could be negated by the others. To tackle inflation, the RBI must keep rates high and liquidity tight, but that can stifle economic growth and push the currency down.
• If it sells dollars to support the currency, that too sucks liquidity out, choking growth. Slower growth makes India an unattractive destination for foreign investors, which in turn leads to drying up of dollar flow.
• But if it releases too much liquidity into the system, inflation could go into double digits and push the value of the rupee down, completing the vicious cycle.

Nature of Foreign Exchange Market:

• The foreign exchange market is the place where money denominated in one currency is bought and sold with money denominated in another currency.
• It provides the physical and institutional structure through which the currency of one country is exchanged for that of another country, the rate of exchange between currencies is determined, and foreign exchange transactions are physically completed.
• The primary purpose of this market is to permit transfer of purchasing power denominated in one currency to another.

RBI as a custodian of India’s foreign exchange reserves

• The RBI acts as the custodian of the country’s foreign exchange reserves, manages exchange control and acts as the agent of the government in respect of India’s membership of the IMF.
• Exchange control was first imposed in India in September 1939 at the outbreak of World War II and has been continued since. Under it, control was imposed on both the receipts and payments of foreign exchange.
• The foreign exchange regulations under the law required that all foreign exchange receipts whether on account of export earnings, investment earnings, or capital receipts, whether oh private account or on government account, must be sold to the RBI either directly or through authorized dealers (mostly major commercial banks).
• This resulted in centralization of country’s foreign exchange reserves with the RBI and facilitated planned utilization of these reserves, because all payments in foreign exchange were also controlled by the authorities.
• The exchange control was so operated as to restrict the demand for foreign exchange within the limits of the available supplies of it.
• Foreign exchange was rationed among competing demands for it according to the government policy.
• All this became essential in the context of actual or potential shortage of foreign exchange, which had been an important constraint on India’s efforts at planned economic development, most of the time.

The Reserve Bank of India:

• The RBI is entrusted with monetary stability, the management of currency and the supervision of the banking as well as the payments system.

RBI manages the foreign exchange operations through two departments, namely:

1. Department of External Investments and Operations, and
2. Foreign Exchange Department.

Department of External Investments and Operations:

• The main activities of the department are management of exchange rate of the Indian rupee, and management and investment of foreign exchange reserves of RBI.

Foreign exchange department:

• With the introduction of the Foreign Exchange Management Act, 1999 (FEMA) with effect from June 1,2000, the objective of the Foreign Exchange Department has shifted from conservation of foreign exchange to “facilitating external trade and payment and promoting the orderly development and maintenance of foreign exchange market in India.”