'Rupee too high but RBI will prop it up'

'Rupee too high but RBI will prop it up'
28 May, 2008.

MUMBAI: The rupee is overvalued and should fall by 10 percent to about
48 per dollar but the central bank will support it to help state-run
oil importers, a member of India's convertibility panel said on
Wednesday. A.V. Rajwade, member of a 2006 central bank-appointed panel
on capital account convertibility, said there was little historical
evidence that a stronger rupee was effective in curbing inflation and
many exporters were not strong enough to shield themselves from sharp
currency gains.

The rupee rose more than 12 percent against the dollar in 2007 and
touched its highest level in nearly 10 years at 39.16 per dollar
<INR=IN> in November. But it has fallen nearly 9 percent so far in
2008 because of portfolio outflows and higher oil import costs, and
hit a 13-month low of 43.21 last week. It stood at 42.85 on
Wednesday.

"The rupee had become absurdly overvalued in my view, probably around
15 to 18 percent, but the central bank will intervene by selling
dollars to arrest the rupee's fall to help oil companies," Rajwade
told Reuters in an interview. "They will have to keep intervening if
they want to keep the rupee around 43 level or it will keep slipping,"
he said.

State-run oil retailers are losing millions of dollars a day selling
fuel at discounted rates set by the government. The falling rupee has
also increased import costs and with oil prices rising, India's trade
and current account deficits are widening. Economists estimate the
trade deficit was $90 billion in 2007/08. "You cannot have the rupee
going up when the trade deficit is at $100 billion," Rajwade said.

Traders say the central bank intervened last week to slow the rupee's
fall, but analysts have been surprised that it did not step in sooner
while inflation is running at 3-½ year high. Other central banks in
South Korea, Taiwan, Philippines and Indonesia have been propping up
their currencies to temper the inflationary impact of rising oil
prices
But Rajwade said China's yuan and Brazil's real had risen in the past
few years and Brazil's inflation was still 5 percent. "The yuan has
appreciated about 15-18 percent and the inflation rate is very similar
to India's, so currency appreciation does not necessarily lead to
lower inflation," he said. The Reserve Bank of India bought $20.3
billion in the first quarter of 2008 to keep the rupee down and has
been a net buyer of dollars in the currency market for more than two
years.

Rajwade said dollar selling by the central bank may drain rupee
liquidity from the money markets at a time when cash is already tight,
eventually pushing bond yields higher. The government gives bonds to
oil retailers to compensate them for their losses, but Rajwade said
this was inflationary in the long term as it did little to check
demand-side pressures. Furthermore, monetary steps would do little to
check high commodity prices as this was a supply-driven problem, he
said.

"None of these are very susceptible to monetary policy as you do not
eat less because interest rates go up." Giving incentives to farmers
to produce more would help bridge the supply-demand gap rather than
using price controls and subsidies, he said.