New Delhi/Mumbai: India announced fresh measures to stimulate foreign currency inflows into the country in an attempt to shore up the rupee, but disappointed investors who were expecting bolder action to support the currency, especially after outgoing finance minister Pranab Mukherjee stoked their anticipation.
The liberalization has once again been targeted to benefit exporters, underlining the strategy of policymakers to provide demand stimulus led by exports. It’s also aimed at reducing pressure on the country’s balance of payments and supporting the rupee.
In measures announced simultaneously by the government and the Reserve Bank of India (RBI), India hiked the investment limit of foreigners in government bonds by $5 billion and increased the external commercial borrowing (ECB) limit. Indian exporting companies in the manufacturing and infrastructure sector with earnings in foreign currency will be allowed to tap cheap ECBs to pay off domestic loans. The rules were also relaxed for investments by foreign institutional investors (FIIs) in long-term infrastructure bonds.
The market was underwhelmed, having expected some big-bang measures after the rhetoric over the weekend by Mukherjee, who’s stepping down as finance minister to contest the country’s presidential election.
“The market reaction says it all,” said J. Moses Harding, head of research at IndusInd Bank Ltd. “The market was expecting some big-bang announcements like dollar bond issuance to the tune of $10-15 billion. Given the crisis situation, this delivery was seen as small and insignificant.”
While the rupee, which had strengthened in morning trade, touching 56.38 against the dollar, closed considerably weaker at 57.01, the yield on the 10-year government bond rose marginally to close at 8.089% against Friday’s close of 8.084%.
The rupee had slumped to a new low of 57.30 to the dollar in intra-day trade on Friday. The domestic currency has lost 21.08% against the dollar in the past one year.
A file photo of RBI governor D. Subbarao.
Gautam Trivedi, managing director and head of equities, Religare Capital Markets, said concrete steps to bring down the fiscal deficit would have been appreciated by the markets. “The increase in the ECB and G-Sec (government securities) limits will be positive for the rupee in the near term, but are unlikely to have any immediate impact on the equity markets,” he said.
BSE’s benchmark equity index, the Sensex, dropped 0.53%, or 90.35 points, to close at 16,882.16, while the broader index Nifty of the National Stock Exchange dropped 0.61%, or 31.4 points, to 5,114.65.
Rajeev Malik, senior economist, CLSA Singapore, said the measures were positive but not as significant as markets expected, given Mukherjee’s statement about major measures. “Once again, the government unnecessarily raised expectations only to disappoint,” he said.
“The steps announced so far are probably minimal at this time,” said R.V. Kanoria, president, Federation of Indian Chambers of Commerce and Industry. “We were hoping for a broad-based set of strong actions as well as policy reforms that could have a positive bearing on the overall environment.”
The measures announced on Monday follow a series of steps by the central bank to provide support to exporters and to stem the rupee’s fall. Last week, RBI increased the limit of export credit refinance for banks to 50% of outstanding export credit from 15%. In May, the central bank directed exporters to convert 50% of their foreign currency holdings with banks into rupee balances within a fortnight.
India’s merchandise exports grew just 3.2% to $24.5 billion in April from a year earlier, weighed down by uncertainty in the euro zone and tepid recovery in the US.
In its mid-quarter review of the monetary policy, the central bank had said that a falling rupee would act as a demand stimulus by encouraging exports and discouraging imports. “Further, one implication of the rupee depreciation over the past several months is that domestic producers have gained in competitiveness over foreign producers. Over time, this should result in expanding exports and contracting imports, thus acting as a demand stimulus,” RBI had said.
Thomas Mathew, joint secretary, capital market division, ministry of finance, said, “The steps will encourage flows into the debt segment and give an opportunity to corporates to access cheaper funds.”
As per a government statement, FIIs can now invest $5 billion more in government bonds, taking the investment limit in government securities to $20 billion from $15 billion. Of the $20 billion threshold, FIIs can now invest $10 billion with no residual maturity restrictions and another $10 billion subject to a residual maturity of three years. Within the $15 billion investment limit, there was a sub-limit of $5 billion for FII investment in bonds with a residual maturity of five years, while there was no residual maturity restriction for investments up to $10 billion.
The limit on both corporate and government bonds was increased by $5 billion back in November, taking the limit to $25 billion for corporate bonds and $15 billion for government bonds. But due to the residual maturity restriction of five years, utilization was only around 71%.
To broaden the investor base for government securities, India has also allowed long-term investors such as sovereign wealth funds, multilateral agencies, endowment, insurance and pension funds, and foreign central banks to invest in them without registering as FIIs.
The government also raised the overall ceiling on ECBs to $40 billion from $30 billion by way of introduction of a new scheme for exporters in the manufacturing and infrastructure sector.
Subject to an overall ceiling of $10 billion, exporters in these two sectors can avail of ECBs for repaying outstanding rupee loans towards capital expenditure, with the maximum amount permissible for an individual company limited to 50% of the average annual export earnings.
To encourage greater foreign investment in long-term infrastructure bonds, the government reduced the lock-in period to one year from three years and residual maturity to 15 months. Also, qualified foreign investors can now invest in mutual fund schemes that hold at least 25% of their assets in the infrastructure sector, subject to the current $3 billion ceiling. The government hopes the move will encourage mutual funds to increase investments in the infrastructure sector.
The government will also soon notify the reduction in withholding tax to 5% from 20% as announced in the budget, Mathew said.