Cross-talk by RBI and govt worsens Rupee outlook
It is not clear whether the current policy of tightening liquidity to save the rupee is largely RBI’s brainchild—chief economic advisor Raghuram Rajan has said the government welcomes RBI’s statement—but it appears to have worsened matters, at least the day the central bank came out with its monetary policy. If the objective of the liquidity tightening was to stabilise the level of the rupee—something RBI denies—then it failed since, with the rupee closing at 60.49 to the dollar on Tuesday, it is worse than the 59.9 it was the night of July 15 when RBI decided to start tightening liquidity. If the idea was to target, and lower volatility as RBI says it is, this didn’t quite work either since the rupee dropped 107 paise to the dollar on Tuesday, a level of volatility not seen in the last few years if you exclude the 106 paise fall on June 26. Interestingly, such volatility will also drive away FII flows since the loss on the value of the currency will be perceived to be greater than potential gains. While it is possible to argue the rupee will correct itself on Wednesday as market-men misread RBI’s signalling on Tuesday, the larger problem is with RBI’s actions. By clamping down on the futures market in currencies, and making the market thinner by the day, in principle volatility is going to increase—ironically, that increases the chances of the current tight monetary policy continuing for a longer period of time.
Nor is it clear why RBI Governor D Subbarao said he was not in favour of either a sovereign bond or that India didn’t need to go to the IMF when it is obvious India has a problem funding $20-25 billion of likely FY14 CAD—in any case, the government has kept the market in suspense by saying all options are open. By the same token, when a high CAD was being run for years, it is not clear why the government never raised funds overseas since the rates would have been attractive then—nor was there any suggestion by it that RBI buy more dollars when the rupee was strong, indeed excessively so.
More curious is the reply given in the Governor’s press conference—not by the Governor though—on a question on the overseas NDF markets. If NDF markets feel the rupee needs to fall further given the fundamentals, the question was, how will curtailing local currency trading help? It is difficult to go along with RBI’s view that the local market determines what happens in the NDF markets since the latter are several times larger. In any case, RBI itself says the rupee is especially vulnerable to global flows since years of running excessively high CAD were funded by volatile short-term flows. In which case, till global markets take a final view on whether QE3 will be eased—and that could be some months—tight money is here to stay. Which is why RBI’s fan diagram on the likely FY14 GDP is worrying—at 50% confidence intervals, the downside estimate of growth is 4.5%, and this falls to 4% at 70% confidence levels. The longer money remains tight, the higher the chances of this happening. Were that to happen, the rupee will fall further.