With the Rupee Collapsing the Reserve Bank of India Decides to… Sell?

India is a fascinating place. There are so many contrasts and contradictions in the culture that it is impossible to understand in a lifetime. Government and policy practice share these traits.

A few weeks ago I blogged that the declines in the Indian Rupee and Indonesian Rupiah could have been completely avoided had the Central Banks in each country opened up their foreign-exchange reserve account and smoothed the capital outflow that was triggered by international events. Instead, it appeared that the central banks were sidelined during this time, electing to protect their reserves rather than purchase some local currency. Not so the Reserve Bank of India…

… Yesterday, new data from the RBI shows that foreign reserve holdings actually increased by $6 billion, the most in almost two-years! Rather than being sidelined during the Rupee decline, it turns out that the RBI was actually selling the Rupee as well!

The stated reason for official selling of the Rupee, and hence the additional reserve purchases, is that the Central Bank is preparing for the potential outflows that may eventuate when the US Federal Reserve begins to taper their asset purchases next year. This seems convoluted logic since it implies that the RBI is prepared to an fuel domestic currency volatility today in the hope of dampening volatility in the future which may or may not happen.

The new RBI governor Mr Rajan was credited with calming the Rupee crisis upon taking office two months ago. This latest revelation may well reignite the Rupee’s decline.