Background
Last week the Reserve Bank of India ( RBI ) raised the CRR ratio by 50 basis points.
Over the weekend, the RBI released figures which showed that India’s forex reserves swelled by USD 5.03 bn during the week ended February 9. This is, historically, the largest weekly rise in reserves.
Curiously, the Indian Rupee (INR) actually weakened marginally against the USD during the above period (weakening from 44.09 to 44.18 to the USD).
This can only lead us to one conclusion. The RBI has been furiously buying foreign currency during the week in question. Many analysts estimate that the total dollar purchases by RBI during the said period to be in the range of USD 3 bn to 3.5 bn.
The sudden fall in overnight money rates during the week in question also points to aggressive liquidity injection as a result of the central bank’s activities in the fx markets.
No wonder, the RBI Governor – Mr. Reddy (pictured above) resorted to raising the cash reserve ratio (CRR). Clearly, the move was aimed at sterilizing this additional liquidity. Of course, with headline inflation well above its own tolerance level, the RBI had a valid enough reason to do so.
Many would argue that using the CRR, a blunt monetary tool, could have been avoided and use of alternative monetary sterilization methods could have been resorted to. The central bank had little choice though. Its securities holding are at bare minimum. Fresh issuance of market stabilization bonds (MSS) are also constrained by refinancing requirements of older MSS bonds due for redemption in the next couple of months.
Inspite of the bluntness of the move, hiking the CRR was probably the most logical option for Mr. Reddy.
Where did all that money come from?
Figures revealed by SEBI show
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Approximately USD 1.15 bn came in as portfolio flows (equity and debt). This includes margin money for fresh derivative positions.
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Some inflows may have been due to normal trade transactions and remittances.
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Some more may have been contributed by Foreign Direct Inflows ( FDI).
However, no large FDI flow seems to have taken place during this period.
The Gap
This still leaves a large proportion (approximately USD 3.0 - 3.5 bn – the amount estimated to have been bought by the RBI ) unaccounted for.
Even if one accounts for valuation gains due to relative currency movements -does anybody have a clue?
Mr. Reddy almost surely does, and he may take his time revealing it.
