While the rupee has been on a hot streak, jumping to an 11-month high against the dollar on hope a new government will usher in a new era or growth for Asia's third-largest economy, India's central bank has been trying to cool the currency down.
The Reserve Bank of India has been raking in dollars from the market, hoping to slow any sharp upward moves in the local currency, dealers and experts said.
Too much appreciation of the rupee erodes the competitiveness of the country's exporters, which could lead to a widening of the country's stubborn current-account deficit.
While last year a sharp rupee depreciation was the RBI's biggest headache, the new normal now apparently is that the central bank is trying to keep the rupee's strength in check.
It has climbed close to 6% since March and was trading at around 58.70 to a dollar on Tuesday amid optimism the Bharatiya Janata Party's convincing victory in national elections last week will allow India to push through the reforms and spending needed to lift the its economy.
The Indian currency may be poised to gain even more ground against the greenback.
"A strong mandate to the Bharatiya Janata Party to form the government and expectations of improving economic prospects through growth in infrastructure, fillip to investments and more job opportunities is adding to the appreciation," said Sugandha Sachdeva, assistant vice-president with Religare Securities Ltd.
Foreign capital inflows are showing a resurgence with investments from abroad already reaching $11.7 billion this year, Bank of America Merrill Lynch said in a report.
"We believe the RBI will use this inflow to continue to purchase dollars on rupee upswings over the medium term, thereby preventing (the dollar from) reaching a level of 55.00, which it views as being over-valued," the report said.
While the RBI's official policy is that it does not target exchange-rate levels, it does admit to stepping into the currency market to control volatility. The RBI spokeswoman wasn't available to comment Tuesday.
For the Reserve Bank, it is a tightrope walk, analyst said.
If it tries to cool the local currency by buying dollars too aggressively, it could create more liquidity than it likes by releasing all those rupees into the market. This could hurt its big battle with inflation.
To avoid this, the RBI has been taking opposite positions in the forwards market to offset the impact of its dollar buying, dealers said. That means that when the RBI buys dollars in the spot market, it enters into a forward contract to sell the greenback, offsetting some of the impact of the intervention.
The RBI may also consider issuing market-stabilization scheme bonds to manage the rupee liquidity. These bonds are special government bonds issued to mop up excess rupee liquidity.
Follow Nupur and India Real Time on Twitter @nupuracharya and @WSJIndia.
(END) Dow Jones Newswires
May 21, 2014 01:25 ET (05:25 GMT)
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