Mumbai: A day after the central bank unveiled a raft of measures to infuse liquidity in the financial system and stem the rupee’s decline, the local currency rose against the dollar and the overnight money-market rate fell, reducing the short-term borrowing costs of commercial banks.
But there was no comfort for equity market investors, with the benchmark index of the Bombay Stock Exchange (BSE), the Sensex, losing about 256 points, or 1.9%, to close at 13,262.90, reversing a short-lived morning rally staged in concert with other markets in Asia and the US.
Swinging Along (Graphic)
The Reserve Bank of India (RBI) had on Tuesday offered banks additional liquidity support and said it would continue to sell dollars through banks to augment supply in the domestic foreign exchange market, or even intervene directly.
The announcement delivered a boost to the rupee, which rose from Tuesday’s low of 46.99 to a dollar to as high as 46.25. The local currency closed at 46.37 a dollar on Wednesday from its Tuesday’s close of 46.93.
“There was huge volatility in the rupee market today after the RBI measures, and I see rupee going back to the 46 level soon, may be within one, or two days,” said Sanjeev Patra, senior currency dealer at Bank of Nova Scotia.
RBI’s measures to ease liquidity also cooled the interbank call money rate, which had zoomed to 16% on Tuesday. The call money rate closed at 10.15% on Wednesday. Banks borrow from the market to meet temporary asset-liability mismatches.
According to foreign exchange dealers, RBI had to step into the market briefly when the rupee hit 46.70 a dollar in the morning because of “huge dollar demand” from companies and importers.
Economists expect further steps from the central bank to shore up market confidence. “We could see the Reserve Bank of India becoming more active in the coming months,” said Rohini Malkani, economist at the Indian unit of Citigroup Inc.
Rate hike concerns ease
According to economists at large local and foreign banks and brokerages, possible central bank measures include a cut in the statutory liquidity ratio (SLR), the proportion of deposits that banks are required to invest in government bonds. SLR is currently at 25%.
The central bank could take steps to attract external capital by easing norms relating to inflows of funds from non-resident Indians and external commercial borrowings.
It could also keep on hold further increases in interest rates, given the slump in global commodity prices, which is expected to ease inflationary pressures.
RBI has increased the cash reserve ratio, or the proportion of deposits that banks are required to keep with it, by 150 basis points and the policy rate by 125 basis points in this fiscal year. One basis point is one-hundredth of a percentage point.
“Given the current global environment and the RBI move, the probability of a rate hike in October has diminished and we are putting our call on one more rate hike under review,” said a research note from US investment bank Goldman Sachs Group Inc. on Wednesday.
Currency dealers said RBI might stay away from the market at the current rupee level and will not sell the greenback, as the regulator’s dollar sales suck out rupee liquidity from the financial system.
On Wednesday, RBI injected Rs59,480 crore into the system in two phases to fund-starved banks.
Since the beginning of the week, on an average, the central bank has been infusing more than Rs55,000 crore into the banking system every day.
The rupee has been declining for the past month because of the dollar’s rally and an acute dollar shortage in the local market caused by capital outflows from slumping equities, offshore demand for rupee forward contracts and demand from oil companies.
The rupee sell-off is “overdone”, said the Goldman Sachs report. Concerns about the vulnerability of India’s balance of payments may be excessive, it said.
“While outflows of FII (foreign institutional investor) investments in the equity and real estate market is a key risk, domestic residents have little appetite for foreign assets and the government has very little foreign currency-denominated debt,” the Goldman Sachs report said.
With the price of global crude oil dropping to around $90 (Rs4,167 today) per barrel, the estimated full-year current account deficit will fall from $50 billion to $35 billion, said Citigroup’s Malkani.
Explaining factors that could work in favour of the rupee, she said that “although portfolio funds will likely remain negative, foreign direct investment (FDI) remains buoyant”. Gross FDI during the fiscal first quarter doubled to $10 billion, from $5 billion a year earlier.
The rupee rally did not spill over to the bond market as traders locked in profits. The yield on the benchmark 10-year paper rose from 8.09% to 8.19% as bond prices fell. Bond prices and yield move in opposite directions. The 10-year bond yield was 9.47% in June.
On BSE, the Sensex swung about 500 points between its day’s high and low. On the National Stock Exchange, the broad-based 50-stock Nifty lost 1.6%, but managed to stay just above the psychological 4,000 level.
“There is reasonable basis to believe that the market might be over-reacting,” said Dhananjay Sinha, strategist and economist at local securities house Centrum Broking Pvt. Ltd, in a note to clients on Wednesday.
The rally in Asian markets was trimmed by continuing worries about more likely financial failures in the US, disappointment over the US Federal Reserve leaving interest rates unchanged and a real estate slowdown in China.
The Chinese benchmark index dropped some 3% on Wednesday while Hong Kong’s Hang Seng slumped more than 3.6%.
The US market had risen on Tuesday after the Fed announced a $85 billion rescue plan for the distressed American International Group Inc. (AIG), the largest insurance firm in the US.
A $1.75 billion deal struck by Barclays Plc. to buy the investment banking assets of Lehman Brothers Holdings Inc., which filed for bankruptcy, also improved US market sentiment and helped the Dow Jones Industrial Average gain 1.3% on Tuesday.
But US stocks tumbled on Wednesday after housing starts slid to a 17-year low and bank lending seized up in the wake of the government’s takeover of AIG. At 8.55pm India time, the Dow Industrials was at 10,773.97 points, down 2.58%.