The Indian Rupee Downfall – What can RBI and Government do to prevent further downfall of Rupee against Dollar?

What steps should RBI and Government take, to prevent further Downfall of Rupee?

Important Steps taken so far

In May 2012, reserve bank of India took following steps to stop the downfall of rupee against dollar.

Reducing the speculative trading

  1. RBI changed the rules related to EEFC Bank Account. 

Reforms in FCNR Accounts

  1. RBI relaxed the interest-rate ceiling FCNR Bank-Accounts and allowed the Banks to use FCNR deposits to provide loans to local residents. 

Selling part of Forex Reseve

  1. in past couple of weeks, RBI itself sold about $200 million from its foreign exchange reserves, to increase the supply of dollars in the market.

Future course of action for RBI and Government

Main reasons why Rupee falls down against dollar?
  1. Because people have to pay in dollars, while they import crude oil and gold.
  2. Because FIIs are exiting Indian Market due to policy paralysis and rumors related to GAAR. 
  3. Current account deficit is merely the outcome of about two problems. 
  4. When people say, “rupee is falling because of large current account deficit ”, it means that supply of dollars is low (from FII/FDI/Exporter etc.) side compared to the demand of dollars (from Gold and Oil sellers abroad/FII exiting from India etc.).
So what can government and RBI do, to tackle this downfall of rupee?

Policy reforms

  • Government could initiate policy reforms to boost foreign direct investment (FDI) in India. Such as FDI in retail-marketing and aviation sector.

Reduce Gold import

  • Recall my previous article on how to calculate “current account deficit”, we've seen that we can never have “surplus” in balance of trade because we import crude oil and gold worth billions of dollars, but our exports are not that much.
  • The crude oil is a necessary evil, without which our industries or life cannot function properly. We export textiles and chemicals, but even for their production, crude oil is necessary. No matter how “climate friendly” it sounds, there is a limit below which, we cannot reduce our oil consumption.
  • “MRP” of gold jewellery will increase instead of “MRP” of gold jewellery demand will increase.  The government could increase the customs and excise duty on gold, that way “MRP” of gold jewellery will increase and consequently, its demand will decrease. (except by those Politicians, Bureaucrats and Real Estate mafias who’ve truckload of cash, and want to invest it in gold.)
  • Recall the Gold Excise duty article, although Pranab did have ‘noble’ intentions of implementing above things, but then he fell back due to public pressure.  

Dollar window for oil firms

  • We know that RBI has forex reserve worth around 290 billion dollars. The RBI could open a special window, allowing the oil companies to sell rupees and by dollars from the RBI itself, rather than from other forex sellers. Thus, saving some money in the commission payment and preventing excessive speculation in the forex market.

Sovereign backed NRI bonds

  • Recall my article on debt versus equity. In that, I discussed about junk bonds versus gilt-edged securities.

India Sovereign backed Bonds

So far, government of India has issued such bonds only three times (with help of SBI)
  1. in 1991, Indian government had issued India development bonds, to borrow $1.6 million from abroad.
  2. In 1998, Indian government had issued resurgent India Bonds, to borrow $4.2 billion from abroad.
  3. In 2000, India millennium deposits, to borrow $5.6 billion from abroad.
  • Generally, these sovereign backed Bonds have maturity period of five years (i.e. you get principal back after 5 yeas) . They are issued in dollar or pound form
  • The interest and principal are paid in the foreign currency itself, therefore, the investor does not need to worry about fluctuating currency exchange rates
  • The Indian government could issue such “Gilt-Edged” bonds via SBI one more time, offering attractive interest rates to the NRIs.
  • Implication: NRIs give their dollars to purchase these bonds, and the dollars, thus collected can be used for lending to Indian oil companies and or Indian Importers/Exporters*.
*ya exporters also need foreign currency! Because sometimes they have to import raw material/services from a third country for producing their own goods and services. Example: import electronic –chips from Taiwan, steel from Russia, plastic from China, and assemble laptops in India and export it to South Africa.
* why NRIs? (Because other FIIs/ foreign investors may not be so interested in investing in India at the moment given the ‘policy paralysis’ and GAAR etc issues)

Allow banks to borrow from abroad

RBI could take a policy initiative, allowing the Indian banks and nonbanking financial companies (NBFC) borrow dollars from abroad and lend it in the local Indian market (i.e. Indian oil companies and Indian businessmen.)