New Delhi/Mumbai:The Reserve Bank of India (RBI) intervened on Thursday to stem the continued fall of the rupee, and announced measures to curb speculation and increase liquidity in the currency market.
The central bank directed exporters to convert 50% of their foreign currency holding with banks into rupee balances within a fortnight. The intervention—the fourth in six days—seemed to suggest it was beginning to focus on quantitative measures to limit demand after having tried to increase the inflow of dollars.
Analysts and economists say RBI’s recent moves—which they believe will have only a marginal and temporary effect—once again highlight the pressure on the Indian currency from the twin deficits—the fiscal and current account.
The twin deficit problem remains, said Samiran Chakraborty, head of India research at Standard Chartered Bank. “We have to reduce our import dependency, bring down subsidy on fuel, which in turn will reduce consumption and import of fuel, opt for a better export promotion strategy, and adjust to a weaker rupee, which will lead to export growth,” he said.
Anup Roy says that while RBI’s measures to defend the rupee might have an immediate impact, analysts don’t lasting changes until the wider economy’s structural problems are tackled
Moses Harding discusses the potential impact of RBI’s new measures to shore up the rupee and how companies might find a way around them
And the nature of these problems would suggest that the solution lies elsewhere—with the government. “The time purchased by these measures should be used to address fundamental issues such as growth, and the current account and fiscal deficits,” said Ananth Narayan G, regional head of global markets at Standard Chartered.
Indeed, RBI is aware that while the rupee will get some relief from its measures, these are unlikely to reverse the trend and that it “at best, wants to manage the adjustment”, said Rajeev Malik, a senior economist at CLSA in Singapore, who expects the rupee to fall further to 55 to the dollar.
Some of the government’s recent policies haven’t helped the cause of the rupee either. The trade deficit in 2011-12 rose to 10.9% of gross domestic product (GDP), a record (it narrowed to a 12-month low in April, largely because of a fall in imports), and both the fiscal and current account deficits have soared, but the situation has been exacerbated by recent policies such the proposed implementation of general anti-avoidance rules (GAAR) that has since been deferred. This move, which would have given the taxman significant powers to target structures adopted to avoid taxes, spooked foreign investors.
“It is capital flows that determine the exchange rate...(and) every time the rupee has depreciated in the past, it has (had) nothing to do with the trade deficit. It has a lot to do with what happens in the stock market,” said Rahul Khullar, India’s commerce secretary. “Don’t you think all this GAAR and other things have had an impact on people moving out of assets?” he asked.
Action and impact
The order to exporters to convert half their foreign currency holdings into rupees is expected to infuse at least $2.5 billion (around Rs 13,325 crore today) into the market, lending support to the rupee.
“RBI’s message is plain and simple—don’t indulge in speculation. Use the currency market for genuine purposes, not for profit making,” said N.S. Venkatesh, head of treasury at IDBI Bank Ltd.
RBI also allowed banks to take intraday positions that are five times the net overnight open limit, a move that should reduce volatility and improve liquidity in the market.
Exporters were earlier permitted to keep 100% of their foreign currency earnings with banks in an exchange earners’ foreign currency account. The balance outstanding in this account is about $5 billion.
The rules also apply to resident foreign currency and diamond dollar accounts, the latter held by those dealing in the precious stones. The combined outstanding amount on these two accounts is around $2 billion, which means $1 billion will flow into the market.
The rupee has fallen around 21% since August 2011, when the domestic currency started depreciating rapidly against the dollar. This is similar to the size of the 1991 devaluation, observed CLSA’s Malik in a note when the rupee fell sharply. With the country’s foreign exchange reserves nearly empty at that time, the government allowed a sharp devaluation of the currency.
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The rupee hit a low of 54.30 on 15 December, which prompted RBI to clamp down on speculation in the currency market by imposing norms that forbade companies from rebooking forward contracts once they have cancelled them. It also restricted the exposure of banks in the currency market. Subsequently, the central bank freed up interest rates on non-resident rupee deposits, and late last week it increased the interest rate on foreign currency deposit accounts and allowed banks to raise foreign currency at any rate.
However, all these steps were unable to arrest the fall of the rupee till Thursday’s RBI announcement, after which the currency rose as much as 1.6% amid speculation that the central bank had also intervened in the market to sell dollars.
Soon after the announcement, the rupee rose sharply to reach 52.95 to the dollar as exporters started unwinding their long positions on the dollar. However, it fell again to close at 53.43 a dollar, against the previous day’s close of 53.83 a dollar.
“This is just preponement of certain supply of dollars, which would have come to the market anyway,” said A.V. Rajwade, an independent foreign exchange dealer. “It will have some one-time effect, maybe will linger for eight or ten days. It doesn’t change the demand-supply mechanism. The real problem is capital flow. FIIs (foreign institutional investors) don’t seem to have much faith in our government. Rupee volatility, Vodafone tax case, GAAR issue, Mauritius treaty uncertainty, and the gaping current and fiscal account deficits have eroded the confidence in our government. The rupee will continue to be under pressure in such an environment.”
As on 27 April, RBI had reserves of $295.36 billion. However, Rajwade said, “The quantity of our forex reserves is good, but not the quality of it.”
The 30-share benchmark Sensex index of BSE ended at 16,420.05 points, down 0.36%. The broader 50-share Nifty of the National Stock Exchange closed at 4,965.7, down 0.18%. FIIs, key drivers of Indian markets, have been net sellers of stocks worth $250 million in the last three sessions, according to Securities and Exchange Board of India data.
Information technology (IT) companies that earn mostly in dollars and primarily spend in the Indian currency head the list of potential gainers from the rupee’s depreciation. However, most large Indian IT firms typically hedge against the dollar (most have done it at 47-48 to a dollar, which will not help), while smaller ones do not have the scale to hedge.
While the short-term impact may be negative on account of hedges, the medium term will be good, said N. Venkatraman, chief financial officer at Sonata Software Ltd. However, because firms are investing more on-site, and making acquisitions, the long-term impact may not be good, he added. “...It is a question of earning in dollars and euros and spending in dollars and euros,” said Jatin Dalal, chief financial officer (IT business) at Wipro Ltd.
Even jewellery companies that earn largely in dollars, see some pain in the short term. “Our inventory is in dollars and our payments are in dollars. However, our mark-to-market and borrowings from the banks are in rupees and as we are all quite leveraged in the short term, the dollar appreciation impacts us,” said Mehul Choksi, chairman of Gitanjali Gems Ltd. In the long run, though, the depreciation will benefit the firm, he added.
Private equity investors said that while currency fluctuations can hurt returns in the long term, high growth and profitability of portfolio companies will keep them afloat. Mukul Gulati, managing director at Zephyr Peacock India, said that if the currency depreciated 20% over a fund’s investment life cycle, then there could be an impact on returns. “We believe that as long as there is strong growth, currency fluctuations should not be a problem,” he said.
Nor will it affect investment activity.
Abhay Pandey, managing director at Sequoia Capital India, said people don’t see currency fluctuation as a criterion for decision-making, so deals will not get impacted. “Overall, 2-3% depreciation has been a historical trend. If it sharpens, then there is a problem,” he said.
Ruchira Singh in New Delhi; Sridhar K. Chari in Bangalore; Sunil B.S., Vyas Mohan, Deepti Chaudhary, and Krishna Merchant in Mumbai; and Reuters and Bloomberg contributed to this story.