A very interesting point has come to my observation today. We all know that the Indian rupee (INR) was on a depreciating spree in the last four months or so. We have seen INR fall to record low of 54 against dollar. A lot of explanations have been given for the same. One of the prime reasons was that it was believed that the Foreign Institutional Investors (FII) had withdrawn money from the Indian market due to loss of credibility caused by a variety of factors.
The surprising fact that has emerged is that this was a false conjecture. Certainly FII did take money out of the market, but it was more than matched by the inflows. The net result was positive, even though it was a tenth of what it was last year. But the larger question still remains. If the FII kept faith in the Indian market, how do we explain the rapid fall of the rupee?
The phenomena can be explained by a combination of two factors- fear and greed. There was a greed among the exporters. They did not convert their dollars into rupees. The reason for this was simple. Seeing the negative market sentiment, they expected the rupee to fall and they wanted to take the advantage of this to earn more value for their dollars. The fear among importers compounded the problem as seeing the falling rupee, they sought dollars. The exporters held them back, creating a scarcity of dollars and leading to its escalation. Thus, a mixture of greed and fear led to the drastic fall of rupee against the dollar.
The RBI's moves in mid-December helped in restoring balance. The moves had an immediate impact on the value of rupee. First, it limited the net intra-day and overnight open positions. Then it reduced the extent to which forward contracts could be cancelled or re-booked. Such moves helped rupee gain on dollar and right now it is about 51.
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