Rupee Rot: Does RBI has a grand plan or is it just confused?

Two days back the headlines went that RBI is perturbed by the rise in inflation along with continuous depreciation of rupee and will thus suck out the liquidity from the system. It announced drastic measures to curb the speculations (read Long Dollars) to restore some pride to the rupee. These were:


1. Reducing the LAF (Liquidity Adjustment Facility) to Rs 75,000 Cr
2. Increasing the MSF (Marginal Standing Facility) rate, which is emergency lending rate at which central bank lends to other banks at time of peak crunch, to 10.25% from the earlier 8.25%
3. Announced an OMO (Open Market Operations) of Rs 12000 Cr. for Thursday (i.e. today)


These were controversial yet big measures.


The LAF facility earlier used to accommodate Rs 1,00,000 Cr day to day lending to the banks. The rate charged for this lending is called Repo Rate which we so widely hear about. Well, even when the cap was at Rs 1L crore, the daily requirements of the banks were consistently hitting Rs 1.4L crore during the peak inflation times. It has only moderated since then but still above Rs 1L Cr. daily. This measure would have made the banks to preserve their cash better as it suddenly increases the cost of borrowing for them. Anything above 75K would have gone for 10.25% MSF rate. Thus it was expected that banks would quickly square off their open positions in currency speculations to use the cash more judiciously. 


It should be noted that, earlier, RBI has asked banks to stop any proprietary currency trades i.e. they can take trades only for their clients and not for their own sake. Now, with this step, the speculative trades against rupee would have died more or less.


An OMO of 12K Cr would have further sucked the liquidity out of the system.


As RBI announced these steps, our exchanges reacted sharply with Sensex falling by around 250 points in the early trades on 16th July, finally settling 183 points lower for the day. Banks, which were expected to bear the maximum brunt fell dramatically. Yes Bank fell around 10% while IndusInd Bank fell by 8% as private sector banks dealing with wholesale loans were expected to get severely hit. Bank Nifty as a whole lost 4.8%. These were big losses. The carnage in the bank nifty continued next day too with Bank Nifty closing another 2.3% lower and breaking the 11,000 mark.



Rupee appreciated in response to the measures and came close to 59 mark again.


However, the steps were being questioned from the time they were announced. Rupee depreciation is a structural issue with our country where the net imports are increasing with each passing day. With the recovery in US and consequent dollar strengthening, rupee has depreciated more than 13% since April to touch its all time low of Rs. 61.21 against the USD. Analysts said that RBI's steps can only be a breather and not a solution to the rupee rot and they were correct. However, I don't think RBI implemented these as a long term solution anyways. The rationale was to cut down the speculation against rupee and this seemed a logical step to do that.


However, since then RBI seems to have faltered on its plans. First it rejected a T-bill auction and allowed some 11,000 Cr odd-liquidity into the system. Also assured Mutual Funds to provide liquidity worth 25K Cr at the penal interest rates. The biggest shocker was the OMO, which was announced to be of 12K Cr. turned out to be of 2.5K Cr only!


This has given us a market where people are extremely short on banks and bank-nifty with liquidity more than earlier! The reaction tomorrow can be unsettling. Bank Nifty already managed to close 2.0% higher by the day end pulling Sensex above 20000. If everything stays as of now, we are in for a gap up opening for tomorrow!


Buy Banks, specially private sector banks for tomorrow. Axis Bank, Yes Bank, IndusInd are the top picks here.
Rate sensitives like Real Estate and Auto should be next in line.  Oberoi Realty, DLF, JP Associates, Indiabulls Realestate, Tata Motors and M&M are some of the stocks to watch out for tomorrow's trade.


Well, I don't know if this was RBI's plan to step rupee fall or not (If there seems to be any plan!) but surely it does not seem consistent with RBI's earlier policies where they stuck to their views even at the face of opposition.
Is Mr. Subbarao trying to play safe given the fact he'll be retiring soon from the office?