The markets have been waiting for some decision to be taken by the government or the Reserve Bank of India (RBI) on the currency. The crazy logic in the market is that as long as the government says that what is happening in the market is all right and that there is no reason to push the panic button, it is assumed that the system is comfortable with the depreciation and the rupee tumbles further. And this is what was happening in the last two to three weeks. Now that there has been some kind of intervention announced by the government, it is worth analysing how it will help the rupee to get stronger.
The measures which have been announced are essentially on the capital account side where the aim is to infuse more dollars into the economy through routes like ECBs, FPI, Masala Bonds etc. There is intent to put some curbs on imports and give a push to exports. There can be no debate that all these measures are positive for the rupee as they attack the fundamentals of demand and supply for dollars.
To understand whether this will work or not will depend on what has been driving the rupee down. There are fundamentals that have weakened though not uncomfortably as our forex reserves at $399 billion though just a notch below the psychological level of $400 billion which still covers 8-9 months of imports. Besides exports too are increasing which is positive for the CAD.
The view here is that the main reason for the slide in the rupee is external factors such as US trade wars with China, US sanctions on Iran and US diatribe against Turkey. All this combined with Fed increasing rates means the dollar is getting stronger and the other currencies weaker. Rupee is going down along with other currencies though the pace may be more rapid than some of the East Asian markets.
The measures announced by the government will work if the primary reason is the former – i.e. weaker fundamentals. In case it is a global phenomenon, then it may not really help to correct the fall though it could cause some reversal in the first two or three sessions.
Also it should be remembered that what the government has announced will take time to work through. There will be a review by companies on the hedging requirements for infra loans from global markets. For this to work, it will take time for companies to take such decisions.
Increasing limits for FPI is good. But we have seen even after March when the limits were increased FPI flows into debt were negative for April-June and have turned out about positive subsequently. Decisions are taken based on how opportunities present themselves in other markets and with the Fed increasing rates India may not be too attractive in the given conditions.
Lowering the ECB tenure limit is a temporary measure because it has a downside of repayments too getting bunched up and hence may not be prudent as a long-term policy. Besides, it is only the better rated companies which have access to this stream of loans. Hence the measure can be seen more as a stop-gap arrangement which may not be suitable in the medium term.
Masala bonds, too, have not quite taken off and a lot depends on the value attached to companies that are raising these funds. Besides, in a market where the rupee is volatile and falling, foreign investors who bear the exchange risk for such investment would think deeper before opting for these bonds.
The talk on curbing imports is again pragmatic. One can curtail imports by increasing duties and this is going to be tricky. Higher duty on gold imports in the past helped to lower demand and hence imports. However, the same on say electronic goods may not deliver similar results and it would be interesting to see how this works out. Today the fad for using the latest electronic gadgets has never been overshadowed by the cost factor and it would be interesting again to see what the reaction of the public would be.
Export promotion has been a longstanding demand of companies in the form of incentives, tax breaks and credit. Again, this works only with a time-lag to the extent that companies are less competitive on price. Indian exports are driven more by global demand factor than price and hence the view here is that while this will help with a lag, the overall impact would not be very significant on the rupee.
Putting all these points together, the important thing would be to see how the rupee behaves on Monday morning as these announcements are presently a set of guidelines provided by the government. While it should be red positively, the impact may not be long lasting if the downslide in rupee is being driven by global factors. All these measures will work around the fundamentals becoming stronger with demand coming down and supply of dollars going up over a time period.
Looking ahead, the government has done what it can to assuage the rupee. The RBI is intermittently selling dollars to steady the rupee. If this does not work out, then we must be prepared for more volatility in the market and while going in for a NRI bond/FCNR swap is the last resort to correct fundamentals, there is little that can be done if the dollar is getting stronger in the global markets and other currencies weaker.
(The writer is Chief Economist, CARE Ratings)
Updated Date: Sep 15, 2018 12:18 PM