|Giving trouble currency|
|Wednesday, 14 December 2011 00:00|
RBI needs to step in, Re fall strengthens case for FII exit
Even if, for the sake of argument, FIIs wanted to invest more in the country despite the falling growth and plunging corporate profitability, the falling rupee poses an additional problem of exchange rate risk—for the year, though, FIIs haven’t pulled out much, though in 2010 their inflows were about $30bn. An FII investing $1 at R50 to the dollar and earning a nominal return of 10% ends up with a minus 5% return if the rupee falls to 58. The falling rupee is also the reason why exporters are holding back repatriation of their proceeds that much longer. In other words, the rupee seems to have got into a self-perpetuating spiral, which means it is now vital RBI starts taking some action. It is true RBI Deputy Governor Subir Gokarn’s statement about RBI’s reserves not being sufficient to seriously defend the rupee was probably ill-advised, but that’s in the past. Indeed, the sharp fall in the rupee adds to inflationary pressures—JP Morgan’s Jahangir Aziz says the rupee’s sharp fall has had the same impact as a rate cut of 200-300 bps. Theoretically, a fall in the rupee makes exports more competitive but, in a depressed global scenario, there’s just that much exports growth that’s possible.
Which is why currency markets will be looking closely to RBI’s guidance on Friday. Apart from the issue of whether India’s ‘core reserves’ are enough, given we don’t run current account surpluses—roughly $140bn of India’s $300bn forex reserves have a maturity of under a year—any RBI intervention in the spot market would also deepen the current liquidity crisis. One way out, since the system is short of liquidity by R80,000 crore, is to lower CRR—a 25 bps cut frees up R15,000 crore—or to conduct open market operations along with a rate cut. Trying to fight against an appreciating dollar, Gokarn is right, won’t do much other than depleting RBI’s reserves and will likely convince market players to bet even more against the rupee. Which means RBI has to look for windows of the dollar weakening and sell in those windows. Stopping oil companies from accessing the market for dollars, around $10-11bn each month, and letting them buy dollars from RBI directly will have a more immediate impact. Another hike in the limits put on FII bond holdings may be a good idea, though the last one seems to have been priced in by currency market. In the final analysis, though, RBI can do precious little if the message from the political class, both in power and in opposition, is that it is going to continue to play ducks and drakes with the economy—if the Cabinet doesn’t pass the food security bill, which will raise subsidies by half (it was deferred on Tuesday with two senior Congress ministers opposing it), this may be seen as a small sign that the government is trying to get serious.