Should RBI defend rupee, or let it find its own level, Pg9

Key Highlights:

• The rupee has experienced a sharp decline, sparking debate on whether the RBI should defend it or allow it to find its own level.
• The rupee's exchange rate is influenced by the relative demand for rupees and US dollars in forex markets.
• The RBI can sell dollars to increase the supply and buy rupees to increase demand, artificially boosting the rupee's exchange rate.
• The RBI intervenes if the rupee's exchange rate changes too rapidly, aiming to maintain financial stability.
• A weaker rupee could help Indian exporters and reduce the trade deficit, but this may not occur due to complexities in India's export structure.
• Letting the rupee fall could lead to further depreciation as importers buy more dollars and exporters defer payments.

Detailed Insights:

• The RBI's official policy is not to target a specific rupee level but to ensure orderly movement in the exchange rate.
• Defending the rupee by selling forex reserves can work in the short term, but the strategy may falter over the medium term.
• Policymakers aim to maintain around 10 months of import cover in forex reserves.
• A significant portion of India's forex comes from investments, which can be withdrawn if investors perceive poor growth prospects.
• A weaker rupee may not significantly boost exports because a large part of India’s exports are re-exports based on imported goods.
• In many export sectors, India is a price-taker and cannot set prices, limiting the benefits of a weaker rupee.
• Letting the rupee fall can disincentivize investments, as foreign investors may receive lower returns in dollar terms if the rupee depreciates.

Key Concepts Involved:

• Exchange Rate: The value of one currency expressed in terms of another.
• Forex Reserves: Foreign currencies held by a country's central bank.
• Trade Deficit: The amount by which a country's imports exceeds its exports.