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Weak Rupee may help RBI recover bond market losses
June, 26th 2008

The weaker rupee may help the Reserve Bank of India (RBI) recover losses it may have incurred in the local bond market. In a bid to prevent the local currency from crossing the 43-mark per dollar, the central bank is said to have sold dollars worth anywhere between $400 and $500 million on a daily basis for the past few days. With the rupee now quoting at close to the 43-mark per dollar, sale of dollars at this moment would provide sufficient gains to the central bank.

It may be recalled that RBI was actively buying dollars when the exchange rate was close to 39-39.50 per dollar. On the other hand, escalating bond yields are expected to have caused the central bank to incur considerable losses on its bond portfolio. Yields on government bonds have risen by almost 75 basis points between March and June (the first quarter) this year.

A senior trader with a private sector bank said, Aggressive dollar-selling by nationalised banks is at the behest of the central bank. There has been heavy intervention in the past couple of days, with nationalised banks estimated to have sold up to $1 billion on a daily basis. However, taking cognisance of the rising price levels and inflationary expectations, RBI raised the repo rate and the cash reserve ratio (CRR) by 50 bps each late on Tuesday evening.

This has now led to the rupee appreciating marginally versus the greenback and RBI has lowered the extent of its intervention on Wednesday. Selling of dollars by the central bank also affects the overall liquidity situation, as it sucks out rupees from the system. Liquidity also has been tight for the past couple of days, with banks borrowing funds in excess of Rs 30,000 crore from the central bank. In addition, it puts pressure on the countrys forex reserves.

The rupee has been under pressure from a number of sources. Foreign banks have been consistently buying dollars in the spot market while simultaneously selling dollars at the offshore non-deliverable forwards (NDF) market where the rupee has been quoting at a weaker rate. This is a method foreign banks having access to the non-deliverable forward (NDF) market use effectively to arbitrage the rate differential, said the trader. In addition, foreign investors have been seen exiting their positions in the stock market and sending dollars out of the country. This has resulted in a further shortage of dollars, even as the central banks decision to sell dollars directly to state-owned oil refiners has eased off a lot of dollar demand from the market.

The rupee has been testing the 43- mark against the dollar for a couple of weeks now. And there have been reports of the central bank intervention at lower levels. While the central bank can not afford to let rupees exchange rate slip too far in circumstances when inflation is already out of control, market participants doubt that such a heavy intervention will be sustainable for too long.

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