Dissonance among policymakers unnerving investors
It is not too clear if investors who sold off in the markets yesterday believe the finance ministry’s reassurance that RBI’s Wednesday measures don’t represent capital controls—the argument is all that has been done has been to remove outward-FDI and individual remittances from the automatic list to the approval-needed list—but it reflects both the lack of clarity in policy making as well as serious gaps in communication strategies. For one, given the small amount that can be saved—total outflows under these heads were under $8.5bn in FY13—it is unclear what savings RBI hopes to achieve. Two, if as the government and RBI argue, lots of countries including those with current account surpluses like Malaysia and Russia have seen their currencies fall against the dollar in recent months, then it is not clear why RBI is taking the extraordinary measures it is to protect the rupee. Not only has the RBI completely inverted the yield curve, and very sharply at that, long-term yields have also risen by 142 bps since July 2, putting a lot of pressure on corporate balance sheets and made investments less viable—the results of the balance sheet losses for both corporates and banks will be clear only in September. Indeed, as the Fed moves towards the taper, and that seems closer with Thursday’s unemployment numbers falling to a six-year low, the rupee will be under even more pressure in the coming months. At that point, will RBI, under a new Governor, carry on tightening, or will it simply give up, saying volatility has been conquered while the rupee is free to find its own level? More important, what will be the level of damage that will have been done by then to economic prospects? Equally important, while the government and RBI are proud to point out that FII investments in equity have been relatively stable compared to those in debt—this is correct, and in August 1-14, $233mn came in the equity segment—it is worth keeping in mind that while $552mn moved out of the equity and debt segment in the second half of last month, $628mn moved out in the first half of this month.
The communication strategies are even more worrying. When RBI first began tightening on July 15, senior government functionaries in Delhi were publicly saying these were temporary measures, completely negating the impression of an RBI determined to save the rupee. The Wednesday measures are even more curious since, if they don’t represent any bringing back of capital controls, as the finance ministry would have us believe, why didn’t RBI make this clear on Wednesday? Which is why, RBI’s exit strategy is going to find few takers in the markets. If RBI-government communication is in tatters, the government-to-government strategy isn’t in much better condition. While the PM has ensured the $1.85 billion Mylan-Agila deal will be cleared, this is to be accompanied by a new pharma FDI policy that will put restrictions on FDI—should potential investors rush through or should they wait? On DMICDC’s R40,000 crore project near the Delhi airport, as FE reported yesterday, an arm of the central government has been resisting directions from the Prime Minister’s Office on transferring land to another arm for over a year. The strenuous efforts to clear both the Food Bill and the Land Bill also make it clear the government is in two minds over whether reforms matter or not. It is naïve to thing one policy variable, interest rates, can resolve so many conflicting policy objectives.