Despite huge dollar-rupee interest difference, funds still not flowing
When RBI tightened monetary policy by dramatically hiking the Marginal Standing Facility rates on Monday, the idea was to prevent people from punting on the rupee. Since bond market rates were low, even a small depreciation makes arbitrage profitable. So, government sources said, and the Prime Minister reiterated at Assocham yesterday, that once the rupee stabilised, RBI could consider rolling them back. The move helped on the first day and the rupee snatched back 52 paise on Tuesday as compared to Monday’s close. But on Friday, with rupee closing at 59.33, it is not clear the move has helped. The rupee closed at 59.39 on July 1, went all the way down to 60.7 on the 8th but recovered to 59.82 on Monday before RBI took its actions—in other words, it is not clear there was a sharp fall that needed drastic action. More important point, if the measures aren’t reversed soon, chances are they could boomerang. Apart from the fact consumption is still fragile and needs lower interest rates to boost it especially since economic growth is still sluggish, high interest rates are making life even more difficult for India Inc. At a different level, a hike in interest rates cause capital losses in debt mutual funds, and so discourage savings in financial assets.
It is early days yet, but there are confusing signals being sent. Since the idea behind the Monday night policy was to suck out liquidity, the window given to banks to borrow R2.16 lakh crore at the repo rate on Tuesday ensured no liquidity got sucked out and banks are comfortable for another week. On Wednesday, a R12,000 crore T-Bill auction (plus another R6,000 crore of state-government paper) which would have sucked out liquidity, got no bidders as RBI refused to accept the high yields being bid; ditto for the open market operations on Thursday where just R2,500 crore of bids were accepted as compared to the R12,000 crore planned; and on Friday, RBI’s planned R15,000 crore of bond auctions saw R3,520 crore devolving on the primary dealers. RBI may be right in not accepting higher yields, but the signal that comes across is a mixed one, of RBI wanting to tighten liquidity but not sure of just how much to tighten. A R25,000 crore window for mutual funds in trouble because of Monday’s hike as well as an increase of a similar amount in export credit refinancing with RBI had the same impact of not sucking out liquidity.
The larger problem is that with the government not doing enough to instil confidence in investors—Monday’s hike in FDI limits was largely a washout as critical areas got left out—there are no FII inflows. Despite a 700 bps differential between Indian repo and US Fed rates, FII debt outflows continue to rise, from $89 million on Monday to $104 million on Thursday. The other problem is that with a $250 billion FII equity portfolio versus a $35 billion debt portfolio, playing the interest rate game is a tricky one—indeed, as RBI Governor D Subbarao had said at LSE on March 13, equity flows may rise in response to lower interest rates even though debt ones might fall. RBI can’t prop up the rupee on its own. Indeed, it may even make things worse.