May 22, 2012 (LBO) – India’s rupee fell to a new low of 55.06 against the US dollar Tuesday after trading curbs were slapped on forward and swap markets. Earlier in May the central bank limited intra-day open positions of banks. Trimming open positions, especially overnight positions, which narrows the depth of forex markets can increase volatility and panic.
The rupee had been sliding since the RBI started to intervene heavily in forex markets last year. A central bank which has a policy rate target, typically sterilizes its foreign exchange sales, adding fresh domestic money into the banking system.
The exchange rate then weakens steadily, undermining credibility and may also trigger capital flight.
Since mid last year, total rupee injections, which can be measured by net credit to the central government has risen from 3955 billion Indian rupees in mid 2011 to 4,800 billion rupees by January 2012 and 5,600 billion rupees by May 2012.