The Indian 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 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 said. "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.
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