New Delhi: Almost a year after Reserve Bank of India (RBI) governor Raghuram Rajan rescued the rupee from a collapse, his war on inflation remains key to safeguarding the currency.
Rajan, who kept borrowing costs unchanged last week even as price gains slowed and foreign reserves climb toward a record, said developing economies with high inflation risk major market volatility when developed nations end monetary easing.
The rupee tumbled 1.9 per cent to 61.095 per dollar in one month, Asia's worst performance, on speculation improving United States data will prompt the US Federal Reserve to raise interest rates next year.
"With external vulnerability reduced significantly and foreign reserves beefed up, India is better placed to deal with the normalisation of US rates," Gaurav Kapur, senior economist at Royal Bank of Scotland in Mumbai, said in an August 8 phone interview. "However, the weakest element in the defence against capital outflows is still high inflation."
Rajan raised borrowing costs three times since taking office in September to rein in the worst inflation among major Asian economies and avoid a repeat of last August's selloff that caused the rupee to sink to an unprecedented 68.845 per dollar. The currency has since rebounded about 12 per cent as global investors bought Indian assets, boosting foreign-exchange reserves to a near record $320 billion last week.
While the rate increases have helped bring inflation below the RBI's 8 per cent target for January 2015, it is set to accelerate. Consumer prices rose 7.4 per cent last month from a year earlier, compared to 7.3 percent in June, according to the median forecast of analysts.
Rajan left the RBI's benchmark repurchase rate unchanged at 8 per cent on August 5 and said there is an upside risk to his goal of slowing price gains to 6 per cent by January 2016. His statement dropped a June reference to the possibility of easing policy should inflation decline faster than anticipated.
High inflation creates a tendency for a currency to depreciate and discourages overseas investment, Rajan said according to an August 7 report in India's 'Economic Times' that cited the governor's comments to local newspaper reporters.
The world is at risk of another financial crisis as monetary stimulus in developed economies encourages investors to take risks and boost asset prices, Rajan told UK newspaper 'The Times'. There will be 'major market volatility' if investors exit their positions simultaneously, he was quoted as saying by the 'Central Banking Journal'.
One-month implied volatility in the rupee, a gauge of expected exchange-rate swings used to price options, has risen 245 basis points from a 2011 low on July 29 to 7.75 per cent. US Federal chair Janet Yellen said last month US borrowing costs may rise sooner should the American labour market improve faster than anticipated by the central bank.
"The RBI's decision to keep rates unchanged is aimed at tackling inflation and strengthening its defences in case there is a bout of volatility," when the US raises rates, Pradeep Khanna, head of currency trading at HSBC Mumbai, said in an August 7 e-mail interview. "The central bank has been strengthening its ammunition by increasing reserves."
India's foreign-exchange reserves held near an all-time high last week as global investors, who pared holdings of local-currency debt by an unprecedented $8 billion in 2013, ploughed back about $14 billion this year, exchange data show. They also purchased a net $12 billion of Indian equities.