An NRI bond is a good idea as flows are slowing PDF Print E-mail
Friday, 29 June 2018 03:59
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Shobhana edit

Rupee is valued just right, so need to panic, but an NRI bond and joining a bond-index will help increase stability


Following a depreciation of the Chinese yuan, and concerns regarding tariff wars and rising crude oil prices, the rupee has plunged to a new low against the dollar, falling through the 69 mark. This, however, is not really worrying because, thanks to robust FDI and FPI inflows, the rupee was overvalued at 65-66 levels. The relief for exports, though, may be short-lived as, with most competing currencies also depreciating, the advantage has been largely negated. Nonetheless, a significant weakness from these levels could hurt the economy by driving up both inflation—imports comprise 30% of GDP—and interest rates. Rising US interest rates have driven out significant foreign money from the bond markets already, and betting on strong equity flows and FDI inflows amidst the uncertainty surrounding the 2019 elections might not be so prudent.

There is no need to panic yet, but if the dollar continues to strengthen and the yuan continues to weaken and capital outflows persist, what has so far been a gradual fall in the rupee could become disruptive. RBI has built up reserves of $450 billion, but is estimated to have sold some $8-10 billion since March. Rather than using up the reserves, India should raise money via NRI bonds like it did in 2013, as suggested by Bank of America Merrill Lynch chief economist Indranil Sengupta in early May—at that point, the rupee was around 67.8 to the dollar. Sengupta argued that a $30-35 billion issuance would change investors’ perception of the Indian currency and steady it; he pointed out that all the three NRI issuances (1998, 2000 and 2013) had staved off contagion in the past while an interest-rate defence had only partial success in one case—when Bimal Jalan was RBI Governor. Sengupta had pitched for an NRI bond in April 2012 when the rupee was at 53, and it fell to 68.8 by the time RBI finally issued the bond in September 2013. The reason why an interest-rate defence doesn’t work is that FPI in equities are about six times that in bonds, and dry up with rising rates. While a $30-35billion NRI deposit will require hedging, these costs will also fall once the supply of dollars in the market increases. Eventually, if the price of oil continues to shoot up and capital outflows accelerate, that is a price worth paying since more forex reserves boost confidence in the currency. Also, together, companies and banks need to repay some $27 billion by March next year. It is quite likely most of this will be rolled over, since these are highly-rated borrowers, though at a higher cost because spreads have increased. Nonetheless, it wouldn’t hurt to have a buffer given the share of short-term debt (including portfolio investments) was just short of 70% of forex reserves in 2017.

The government does have other ways to attract capital inflows; it could raise the limit for portfolio investments in the bond markets or India could join an index fund. Raising the limits doesn’t guarantee that funds will flow in—especially in the near term when money is still moving out. Joining an index fund is a better option since it would ensure a minimum allocation from various investment funds. However, the ceiling on investments would need to go if India is to be part of a fund. Normally that will provide more stability to flows, but, if the government is not yet ready to move towards index funds, an NRI bond issuance is a good option.



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