RBI’s measures to contain rupee volatility may hurt bank earnings

RBI’s measures to contain rupee volatility may hurt bank earnings
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First Published: Wed, Dec 21 2011. 12 25 AM IST

File photo of the Reserve Bank of India in Mumbai. AFP
File photo of the Reserve Bank of India in Mumbai. AFP
Updated: Wed, Dec 21 2011. 12 25 AM IST
For now, the Reserve Bank of India’s (RBI) measures to curb speculation in the foreign exchange market haven’t stopped the slide of the rupee. Not only that, they have disclosed other problems.
File photo of the Reserve Bank of India in Mumbai. AFP
The central bank has disallowed cancellation and rebooking of forward contracts, placed limits on hedging by traders and foreign institutional investors, and cut the dollar amounts that authorized dealers can hold overnight. Immediately after RBI announced these measures on Thursday, the rupee reversed its decline.
But the local currency resumed its decline after that. On Tuesday, the rupee slid further to close at 52.89 per dollar.
The measures reek of desperation. The consensus is that the rupee will likely be weak for some more months because of the weak economy. Simply put, inflation is high, the current account deficit is widening, foreigners are withdrawing money and other capital inflows are shaky.
So these steps, at best, may work in the short term. Still, some dealers say that had these not been introduced, the rupee may very well be hovering around 56-58 to the dollar. But problems remain.
For one, these steps have led to a liquidity squeeze in the currency market. As Mint reported on Tuesday, companies and banks are finding it difficult to get quotes for foreign exchange transactions. While it is not possible to get daily data volumes for the over-the-counter foreign exchange derivatives market, currency futures volumes traded on three stock exchanges too have fallen since Thursday. On Tuesday, combined volumes on the three bourses fell to 42,18,025 contracts, less than half of what was traded on Thursday. Citigroup Global Markets Inc. estimates that RBI’s steps will eventually shave off 25-30% volumes in the currency markets.
Second, banks’ earnings, which have already been under pressure this fiscal due to poor asset quality, rising interest rates and slowing credit growth could get hit further. A fall in volumes will impact banks’ fee income.
For large domestic banks, Citigroup estimates that foreign exchange transactions account for 1.5-4% of total revenue and 6-16% of pre-tax income. Thus, a one-third reduction in volume could lead to a 1.3-3.2% cut in pre-tax income for these banks. The brokerage estimates that the banks that could get hit the most are the country’s three largest private banks—ICICI Bank Ltd, HDFC Bank Ltd and Axis Bank Ltd—which might see pre-tax earnings drop 2.2-3.18%.
Graphic by Yogesh Kumar/Mint
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First Published: Wed, Dec 21 2011. 12 25 AM IST
More Topics: Mark To Market | Ravi Krishnan | RBI | Rupee | Banks |