Leading brokerage Bank of America - Merrill Lynch (BofA—ML) has said that the Reserve Bank needs to intervene in the forex market to recoup the rupee and thus arrest the imported inflation, considered the main reason for spiralling prices.

Stating that lending rate cuts and higher forex reserves hold keys to the market and growth recovery, a BoA—ML India report, authored by its chief economist Indranil Sen Gupta, said: “The rupee will remain volatile till RBI recoups the forex reserves of USD 65 billion, including the forwards which it had sold since the 2008 global credit crisis following the fall of Lehman Brothers.”

“We do not expect the forex market to get bullish on the rupee until the RBI has recouped forex reserves. After all, the country’s import cover has halved to just about seven months — the least since 1996.” He said

“The RBI will need to buy USD 90 billion if it is to replenish the import cover to even nine months. Just as importantly, the forex market will also fear that the rupee may see disproportionate losses in case the dollar shoots up,” Mr Sengupta said.

The report also said that to stabilise the rupee “the best solution surely will be for RBI to accumulate forex and buy the rupee.”

On imported inflation, it said a 10 per cent fall in the rupee translates itself into a 100 bps rise in inflation.

Stating that non-intervention is the reason for the rupee fall, it noted that RBI is not buying forex to comfort the market because it thinks that market may sell the rupee due to a forex shortage which will further fuel inflationary pressures.

The report notes that “in September-November 2011, the steep 13.4 per cent of the rupee depreciation was, after all, aggravated by payment of bunched up dues of about USD 5 billion to Iran for oil imports. A 10 per cent depreciation of the currency typically translates into 100 bps of inflation.”

The rupee is the second worst performer among the BRICs currencies, after the Brazilian real, losing nearly 19 percent since September 2011, the report said.

Last Friday, the rupee hit a two-month low of 55.15 to the dollar. The life-time low of the local unit was in mid-June when it had plunged to 57.15 to the greenback. In the year-to November 2, the RBI had sold over USD 21 billion to prop-up the rupee. Between August and December 2011, the rupee had lost 17 percent.

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