Decoder: Why rupee crossed 65 against dollar

The rupee on Thursday hit a new low of 65 to the dollar amid investor scepticism about the policies ofthe Reserve Bank of India and the Manmohan Singh government. Traders said the sell-off was intensified by “policy flip-flops” from the RBI. On Tuesday, the RBI announced that it would inject over $1 billion into the markets, just days after saying it was working to tighten liquidity.

India, however, is not the only country suffering from a weakening currency. Other emerging markets like Brazil, Indonesia, Russia, Turkey and South Africa are also witnessing a huge currency volatility because of fears that US may end its quantitative easing by year-end.

The minutes of the Fed’s July 30-31 meeting, released on Wednesday, showed that almost all of the 12 members of the policy-making Federal Open Market Committee agreed changing the stimulus was not yet appropriate but theminutes provided few clues on the potential timing for a reduction and did not mention September specifically, but they did little to dissuade predictions.

“The tone of the minutes do not meaningfully reduce the risk of a September taper,” Omer Esiner, chief market analyst at Commonwealth Foreign Exchange Inc in Washington was quoted as saying by Reuters, noting that jobless figures for August would be crucial.

Ashutosh Raina of HDFC Bank said that, “Yesterday’s Fed minutes confused the markets, not giving timing on tapering. Across the board, EM currencies sold off and the sell-off in equities are also adding to the pressure.”

In June, Chairman Ben Bernanke sparked an abrupt bond selloff when he said the Fed expected to trim QE3 later this year and to halt it by mid-2014. In recent days, currencies from India to Indonesia have tumbled as investors fear tighter Fed policy will starve emerging markets of investment.

Here are ten things you need to know about why the currency has depreciated despite RBI measures

•There are domestic and global reasons for the rupee’s free fall against the US dollar. Among domestic reasons are high current account deficit and growth concerns. On the global front, the recovery in the US economy is expected topromptthe central bank there to end the loose monetary policy by the year end.Anticipating this, foreign investors are pulling out their money from India to invest it back in the US, which is resulting in ascarcityof dollars in India. This is not India specific. All emerging market currencies are witnessing a similar capital flight. US recovery is also boosting the dollar strength.

According to_Bloomberg Correlation-Weighted Indexes_ that track 10 developed-nation currencies, the pound has gained 0.6 percent this year after earlier dropping as much as 6.9 percent, the euro has climbed 6.4 percent and the dollar has strengthened 4.7 percent.

• Domestically, the Indian authorities firefighting did more damage to the rupee than salvaging it. While the government has opened up sectors for foreign direct investment, the RBI has resorted to interest-rate defence of the currency. FDI measures are likely to be fruitful only over the long term, while RBI steps are seen largely as bandages that will be effective only for the short-term.

In order to arrest the volatility in the forex market, the RBI started tightening its monetary policy July 15. It signaled increase in short-term rates by hiking marginal standing facility rate by 200 basis points. On 23 July and 8 August, it followed up with further tightening measures. All this while, the rupee continued to decline and interest rates kept going up.On 20 August, the RBI signaled a reversal of tightening policy.

According to Macquarie, the Reserve Bank of India is sending confusing signals on monetary policy, due to which rupee will continue to depreciate.

According to Nizam Idris of Macquarie,RBI’s announcement to buy bonds has confused the market and by buying bonds the central bank is subsidising outflow at a better price, so the market is still looking to sell the rupee.

•Last week, RBI restricted how much Indian citizens and companies can invest abroad to reduce pressure on the rupee, while targeting the current account deficit by banning imports of gold coins and medallions among other measures.

[caption id=“attachment_1038181” align=“alignleft” width=“380”] Reuters[/caption]

The RBI also eased some of the rate limits for deposits targeted at non-resident Indians (NRIs), though that is also seen as unlikely to attract inflows in the near term given that NRI deposits have seen net withdrawals of $1.1 billion in May and June, according to DBS.

• Efficacy of the steps remains in doubt, given outflows have already been declining this year and that they ultimately do not address the need to attract overseas investments to narrow a current account deficit that hit a record 4.8 per cent of gross domestic product in the year ended in March.

•Instead, traders fear the capital restrictions could adversely impact company profits and could lead to stronger capital restrictions that would scare off foreign investors at a time when the expected tapering of US monetary stimulus is already creating uncertainty in emerging markets.

• The intensity of the fall is surprising but the fall in itself was not surprising, said Sanjay Dutt of Quantum Securities. “Some of the measures taken by the RBI etc, haven’t seemed to have gone down well with the market participants who feel they are very inward looking and retrograde in a manner,” he told CNBC-TV18.

• “The steps taken so far only target residents, but if this raises expectations that they could potentially resort to capital controls targeted at non-residents, that could have adverse near-term implications for capital flows,” HSBC’s Chief economist for India and ASEAN Leif Eskesen said.

“It will, therefore, be critical to tread very carefully when it comes to capital controls, to anchor expectations, and also not use it as a substitute for more appropriate and effective measures,” Eskesen said in a note to clients," he added.

•A Reuters poll showed short positions in the Indian rupee have hit the highest in two months amid sustained doubts over policymakers’ ability to stabilise the currency. Measures to restrict capital outflows come as overseas investments from India had already been on the wane, averaging a monthly $400 million in the first half of the year from $710 million in 2012, according to DBS data.

• To prop up the rupee in the near-term, markets would need assurances that India can attract foreign flows in an increasingly difficult global environment. Foreign investors have sold a net $11.6 billion of Indian debt and equities since late May.

• The government has also raised import taxes on gold and silver in an attempt to narrow the burgeoning current account deficit. The import duty on gold was hiked to a record 10 percent, the third such increase in eight months, while duty on silver was hiked from 6 percent to 10 percent. The excise duty on gold bars was hiked to 9 per cent from 7 percent.The hike in duties came after Chidambaram said the government was looking to contain gold imports at 850 tonnes this fiscal year, after imports of 950 tonnes last year. However, as Firstpost said earlier, Chidambaram may be forced to introduce more curbs on goldif the 850-tonne limit is to be adhered to.

During the first quarter, global demand for gold fell 12 percent to 856.3 tonnes against 974.6 tonnes in the corresponding period last year. But in India consumer demand for gold in India jumped 71 percent to 310 tonnes, compared with 181.1 tonnes in the year-ago period despite repeated increases in import and excise duties by the government this year.

**Firstpost view:**RBI’s latest measures may curb short-term outflows, but they send a chilling message of serious crisis. The limited freedom that Indians-ordinary citizens and businesses-enjoyed on capital account convertibility is now being rolled back bit by bit. They can’t buy gold without paying more for it; they can’t buy property; and they can’t invest abroad easily to expand business opportunities. India Inc will not be happy. ( Read more here)

With inputs from Reuters