By Tejendra Pratap Singh

One can’t forget the period between August and September 2013, when the Indian Rupee was in rapid decline. Having touched 68.80 against the US Dollar, it bounced back to 62 due to the combined efforts of the North Block and Mint Street. The fall in Rupee was attributed to various domestic and international factors. India’s Current Account balance was in doldrums, inflation was near 10 percent and growth was stagnating. To top it, the chairman of the US Federal Reserve, Ben Bernanke said that Fed will soon start slowing the pace of its assets purchase program (also called Quantitative Easing(QE)) and raise interest rates as the economy was in better shape. This triggered a capital outflow rally which led to the depreciation of the Rupee. In this article I will look at some of the steps that the Reserve Bank of India took during the “mini crisis” and where we currently stand, barely two months away from the first interest rate hike by Federal Reserve.


Due to the near zero interest policies followed by the central banks of advanced economies in the aftermath of the financial crisis, yield chasing money made its way to emerging market economies like India. Figure 1 gives a clear picture of how large the capital inflow was in the period following the Global Financial Crisis (GFC). During this period there were no major structural reforms undertaken by the government. Growth was tepid, Subsidy BillS were sky high and the Indian government was slapped with massive corruption charges. All this contributed to the negative expectations of foreign investors. These claims are substantiated by the Figure 2 and Figure 3 respectively, which show the Current Account Deficit (CAD) and GDP growth rate.

graph 2


On June 19 after the Federal Open Market Committee (FOMC) concluded its two day meeting , Ben Bernanke said that “Labor market conditions are improving and Federal Reserve will soon slow down it’s pace of Asset Purchases.”

Market Participants believed that this was a precursor to the eventual interest rate hike by Fed. This led to the flow of easy money from India along with other emerging market economies. This led to depreciation of the Rupee to extreme levels of 68 per Dollar as shown in Figure 4. The problem cam to light with the massive amount of Dollars required by various OMC’s (Oil Marketing Companies) to pay their import bills.


graph 3


graph 4

Steps to Curb Depreciation:

When the Rupee was tumbling, Duvurri Subbarao the then RBI Governor was ending his term. There were talks of Raghuram G. Rajan, the then Chief Economic Advisor to the Government of India taking over. When his post to head the central bank of the world’s largest economy, was formally announced on 4th August 2013 then the Rupee was at a downfall. When he finally took over the realms of RBI on 13th September 2013 the rupee has bounced back from 68 per dollar to 63 per dollar levels due to various measures undertaken by him in collaboration with the Central Government. Figure 5 below substantiates these claims.

To make sure that the recovery is was not temporary, he undertook measures like increasing the Marginal Standing Facility which is the rate at which the banks borrow money from RBI to meet there short term liquidity requirements.

Also to suck up the excessive liquidity Dr. Rajan immediately sold bonds worth 12,000 crore which resulted in the tumbling of bond prices and yields increasing. This ultimately resulted in capital inflows by FII which have deserted the Indian markets. Furthermore, caps were put on gold imports.

To address the issue of sky high inflation Dr. Rajan took to interest rates. During his first review of monetary policy he raised he repo rate by 25 basis
points. (Repo rate is the rate at which the banks borrow from RBI). What followed the first rate hike was a tough monetary policy by Dr. Rajan. He
increased repo rates all the way to 8.75% as he believed that it was important to break the back of Inflation which not only erodes the households of their purchasing power but also hampers the growth and finances of the economy.

graph 6

The Indian economy has been projected as the fastest growing economy in FY- 2015-16 with a annual growth rate of 7.5%. As can be seen from figure 2, CAD is under control. Figure 6 shows that steps to curb inflation have succeeded. (Which is under the target range of 6% as set by RBI.)

It has been widely speculated that Fed under the leadership of Janet Yellen will begin to raise rates from September 2015 onwards. If we see the current macroeconomic environment of the Indian economy then, it can be considered as the only bright spot in the troubled world economy. The RBI has been building reserves to mitigate any adverse impact of capital outflow which might ensue post September. Figure 7 justifies this claim.

We have a seemingly strong government at the centre, one that wants to usher in a new era of reforms. However, it has stalled in its mission due to the short sightedness of the oppositon . This might cost us dearly in the future.

graph 7

graph 8

The writer is an economics student at Delhi University.

Posted by The Indian Economist