The Indian rupee hit a record low of 61.80 against the dollar on Tuesday triggering a panic selling in equity markets with the benchmark BSE Sensex tanking 449 points or 2.34% amid fears that costly imported raw material and rising foreign debt costs will squeeze firms' margins and profitability.
The Reserve Bank of India (RBI) swung into action selling dollars through state-run banks to prevent further currency shocks, forex dealers said as the rupee rebounded to close at 60.77 to a dollar.
A weak rupee, which has fallen 15% since May, besides making overseas travel expensive, can also fan inflation by making fuel and other imported goods costlier.
The RBI has already taken steps making funds costlier for banks and more such steps can force banks to raise lending rates pushing up loan EMIs for individuals.
Also, the record current account deficit (CAD)-the difference between dollar inflows and outflows-- may restrict the RBI's elbow room to prop up the rupee by dipping into its $285 billion of foreign exchange reserves, enough to cover imports for seven months, analysts said.
India's policy makers moved to soothe nervous markets saying it was ready with an action plan. Finance minister P Chidambaram said that the government was monitoring the situation closely.
"The government is continuously monitoring the emerging external sector developments leading to higher current account deficit (CAD) and rupee depreciation. (The government) has taken a slew of initiatives to boost exports and reduce imports, encourage capital flows to facilitate financing of CAD and stem the volatility in the exchange rate of the rupee," Chidambaram told the Rajya Sabha in a written reply.
Chief economic adviser, Raghuram G Rajan, who will take over the as new RBI governor on September, said: "The government and the RBI are working together to address these challenges. We do not have a magic wand to make the problems disappear instantaneously".
Chidambaram also said that the rupee depreciated on account of anticipation that the US Federal Reserve could begin tapering its asset purchases.
The US Fed is pumping in $85 billion (about Rs 5 lakh crore) a month in the US economy as part of a plan designed to aid the economic recovery.
Part of these funds came into Indian equities. But, with incipient recovery signs in the US, portfolio investors have begun withdrawing money from Indian markets fearing the countdown for the withdrawal of the stimulus programme will soon begin.
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