Forex

Government's new ally wants to use country's $311 billion currency reserves to fight inflation by pushing the rupee up, but strategists say the flow of funds is against the currency so the idea is unlikely to work.

A senior official of the Samajwadi Party, which stepped in to support the Congress-led coalition after its communist allies pulled out, said the government should push the rupee to 39 per dollar to bring down 13-year high inflation.

Inflation is above 11 per cent and policy makers are nervous it will be a big election issue when the country goes to national polls sometime in the next 10 months. The rupee hit a 15-month low of 43.49 per dollar last week, and, at 43.16 on Wednesday, is 8.7 per cent down from the start of the year.

It hasn't been near 39 since November. A widening trade and current account deficit and an outflow of $6.7 billion from shares this year have combined to send it lower, making it the worst performing currency in Asia.

"Put very simply, the balance of payments does not support the rupee as before," said Irene Cheung, a strategist at ABN AMRO in Singapore. "Even if they want to do it, they can't do it." "They had the chance at the start of the year when inflows supported it but they missed it and now it is going to be very hard to engineer an appreciation when the sentiment has changed."

Cheung expects the rupee to fall to 44.20 by September and a poll of 12 analysts last week also forecast it would be at 44 by September before returning to 43 by December. The current account showed a deficit in the March quarter for the first time in seven years and a poll forecast the trade deficit to soar to $124.7 billion in 2008/09, or more than 10 per cent of GDP, from $90.1 billion last year.

The global credit crisis and the rally in the oil markets has meant foreigners are not keen to invest in shares and refiners are paying more for crude, leading to larger outflows and deteriorating economic fundamentals. Analysts said supporting the currency would be easier when inflows are copious as the RBI could just scale back on its dollar-buying, but trying to orchestrate rupee gains at a time of outflows would only attract currency speculators.

Using the rupee as an inflation-fighting weapon may have been possible last year and even in early 2008 when the country was swamped by capital inflows but the stock market has fallen 32 per cent this year and investors are wary of slowing growth.

"Spending billions of dollars of reserves on something on which the final outcome might at best be temporary may not be very comfortable with the RBI," said Sean Callow, senior currency strategist at Westpac in Sydney. South Korea has sold billions of dollars recently in an attempt to shore up the won and prevent currency weakness from adding to inflation.

Analysts said raising interest rates to clamp down on inflation may eventually support the rupee and, further down the line, so would allowing foreigners to buy more local assets. "Their policy is now to stop a sharp fall rather than chasing one of outright gains," Cheung said.