RBI's panic moves trigger market, rupee mayhem

India is panicking on the rupee (INR) and that is feeding panic into the currency markets that, in turn, is taking the INR to all-time lows. The INR crossed all-time lows of Rs 61.80 to the US dollar post India’s actions on capital controls. The INR weakness is feeding to equities and bonds with the Sensex and Nifty down by 3.5 percent each while the 10-year benchmark bond yield is up 10bps to trade at over one-year highs.

At around 3 pm, the BSE Sensex was over 700 points down at 18,667.

The RBI, on the eve of India’s 67th Independence Day, reduced the investment limit for Overseas Direct Investments (ODI) from 400 percent of net worth to 100 percent of net worth through the automatic route. The central bank also reduced the limit under the Liberalised Remittance Scheme from USD 200,000 to USD 75,000. The central bank is effectively curtailing Indians from investing abroad.

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[caption id=“attachment_1038379” align=“alignright” width=“380”]  The move on capital controls by the RBI is by far the most damaging for the INR. AFP[/caption]

The move on capital controls by the RBI is by far the most damaging for the INR. Foreign investors will now worry about some form of capital controls on their investments. The fact that the Indian government is falling head over heels to bring in foreign investors will not prevent worries on capital controls in the minds of the investors.

The RBI should have realised that the move on capital controls on Indian’s investing abroad would never work to stem the INR fall. The world is replete with countries that have failed to prevent currency depreciation through capital controls. Malaysia in the late 1990s and Argentina in the 2000s are examples of capital controls that never worked. Iceland imposed capital controls post its crisis in 2008 and has still not been able to roll back any of the measures.

Why did the RBI panic on the INR? Okay, it is trading at all-time lows against the USD but in terms of many factors such as foreign exchange reserves at seven months’ import requirements and external debt to GDP ratio at around 21 percent, India is nowhere near any kind of balance of payment crisis. Countries that have resorted to capital controls in the past had external debt to GDP ratios of over 100 percent.

It is difficult to understand the RBI’s panic reaction on INR fall, especially after it imposed curbs on gold imports, tightened liquidity conditions and imposed limits on speculative positions on the INR in the market. It is true that the central bank has in no way curbed foreign investors from bringing in and taking out money freely from the country but even a hint of suspicion that this could happen is enough to take down the INR.

RBI and the government will now have to send out clear messages to foreign investors that there will be no controls on their investments in India. However, the damage has been done and markets will trade weak until some calm emerges. The calm can emerge only when foreign investors do not fear capital controls.

The Indian investor is hit badly. The weak INR is hurting equity and bond markets. RBI has prevented the Indian investor from investing abroad. The Indian investor will now go into a shell by placing money in fixed deposits and with banks hoarding on liquidity, there will be no flow of money to the industry. India’s economic growth will be hit badly leading to more pressure on the INR to fall.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.