Yesterday, the Finance Minister said many contradictory things: there is no cause for alarm on the rupee; and yet banks must discourage customers from investing in gold. Banks must also cut interest rates.
"There is no alarm bell on the rupee front. I think the rupee will soon find its stable level. (Foreign) inflows are good. In the past two months, it was extremely good," DNA quoted him as sayng.
But the rupee hit 57 to the dollar yesterday (it is currently around 56.77), and the prognosis is that it is heading lower, perhaps even testing 60 at some point during the year if capital flows reverse. So why is there no alarm on the rupee?
In June so far, foreign institutional investors (FIIs) have been selling more than buying, with the minor positive flows in equity (Rs 840 crore) being more than cancelled out by huge debt outflows (Rs 3,994 crore).
His second statement effectively contradicts the first. Chidambaram has asked banks not to encourage investments in gold. He said: "Banks have a role to play in dampening the enthusiasm for gold... I would urge all banks to please advise their branches that they should not encourage their customers to invest in or buy gold".
Quite apart from the fact that it is not the FM's job to tell banks how to conduct their business, the point is his statements betray real alarm over the rupee. This is what he said about gold: "Gold imports have been a major contributor to the CAD (current account deficit). With the sharp drop in gold prices, millions were happy. I am afraid I was not among the millions. I told the (RBI) Governor that the drop in gold prices internationally is a bad news for India. Our fears came true."
He acted on his fears yesterday by raising the import duty on gold by another two percent. This will raise domestic prices. The problem is Indians see gold in a positive light whether it is rising or falling. If it rises, it convinces them that gold is a good investment. If start buying more.
So what is Chidambaram saying? That he has no worries about the rupee, but many worries about gold, which will dent the CAD and impact the rupee. The higher the CAD, the greater the pressure on the rupee to decline.
But there are more contradictions in Chidambaram's various statements yesterday. Another report says he has asked banks to cut interest rates, while pointing out that the Reserve Bank of India (RBI) "has already cut the repo rate by 125 basis points since early 2012, with commercial banks cutting rates by only 30 basis points over the period." His advice to banks: "As CPI inflation and deposit rates fall, I would urge commercial banks to translate monetary policy to retail borrowers and firms through lower lending rates."
All three issues are closely related. A drop in interest rates can impact the rupee and dollar inflows negatively, just as an increase in gold imports is now doing - but Chidambaram managed to say all things.
The impact of falling rates is there for all to see. FIIs are packing their bags from the debt market as yields on government bonds are falling. The 10-year Indian government security currently offers a yield of around 7.2 percent, while the US-treasury bond of similar tenure is around 2-2.2 percent. Adjust for relative inflation rates, and the US dollar 10-year bond looks a better bet than rupee bonds.
Not surprisingly, The Economic Times reported yesterday that FIIs were heading for the exits. The newspaper said: "FIIs have sold Rs 11,300 crore worth of bonds in India for 10 trading days beginning May 22, the first time since they were allowed to buy fixed income securities in 1998...". The sales will be higher now, since the FIIs sold Rs 1,476 crore more in the debt market on 5 June.
The logic is simple, as the newspaper explains: "The gap between the US treasury and India G-Secs has narrowed from nearly seven percentage points to around five percentage points. Global investors usually hedge against currency movements. With hedging cost at about 6.5 percent, an international investor in Indian bonds will end up losing money. A 2.2 percent return in US dollars is a more preferred option for FIIs."
The poser for the FM is this: if debt is no longer attractive, FII inflows will now stand on only one leg - equities. And if, as he is urging, interest rates are cut further, there is even less reason for FIIs to invest in Indian debt.
The critical question is whether equity inflows will outweigh debt outflows. On that depends the answer to where the rupee is headed.
The pressure is clearly downwards, never mind the FM's valiant efforts to talk it both the rupee and the stock markets up.