Sensex drops 505 points, rupee still below 72-mark: Why Arun Jaitley’s Friday pills did not work to cure currency's fever

On Monday, just two days after Union finance minister Arun Jaitley announced rupee saving measures, the Sensex fell  505 points on BSE and the rupee the rupee inched closer to the 73-mark against dollar. Clearly, the currency and equity markets are not too impressed with the five points package intended to offer rupee a booster-dose. Why? The government did what it could. But the reason for the rupee’s free fall has more to do with external factors rather than on account of domestic fundamentals and capital account problems. Hence the measures failed to cheer the markets. In simple terms, the five measures the government announced on Friday were intended to encourage foreign fund flows to the domestic market through a range of instruments such as relaxed external commercial borrowing (ECB) norms, FPI (foreign portfolio investments), Masala Bonds and some measures to push exports. [caption id=“attachment_5191911” align=“alignleft” width=“380”] File image of finance minister Arun Jaitley. Reuters.[/caption] All these are directionally positive measures that will augur well for rupee in the long-term but not in the short term. But as Abheek Barua, chief economist of HDFC bank, points out in a recent note, while the government believes that these five measures could to lead to additional capital flows to the tune of $5 - 10 billion and limit the currency pressures to some degree, it is doubtful about the impact of such measures in the immediate future. “In our view, the capital account measures announced yesterday are unlikely to result in any significant shift in fund flows in the immediate future. These measures are better suited when the sentiment in the global market is positive towards emerging markets and in general when it is relatively easy for emerging market corporates to raise money abroad. For example, the demand for masala bonds from offshore investors is generally driven by the stability of the rupee. In an environment, when the rupee is under pressure, a foreign investor would not be much willing to increase its portfolio of rupee-denominated assets (unlikely to bet further on the rupee),” Barua said. The rupee has lost around 14 percent against the US dollar since the beginning of the year while foreign institutional investors (FIIs) have net sold a total of $ 3.8 billion in domestic equity markets (secondary). The problem with the current round of rupee fall is that, as mentioned before, the mess in the global economy remains the villain. Of these, the main problems include the US-China trade war, the developing problems in the crisis in Turkey, the likely interest rate hikes in the US, picking up of economic growth and corresponding strength in the US dollar. It’s not just the rupee but its peers in emerging markets too have taken a beating against the US dollar. India’s ballooning deficits that have a lot to do with rising import bill domestically puts additional pressure. Unless the global environment settles down,  the rupee is likely to continue its free fall. What are the options India has to contain the rupee slide? The measures announced so far will help in the long-term but not immediately. The government can still go the extra mile and announce an non-resident Indian (NRI) bond to shore up the currency, but that will be the last resort on account of economic implications. The Reserve Bank of India (RBI) seems to be comfortable with a depreciating rupee compared with the previous occasions of the currency slide. Why? May be the central bank considers the rupee is overvalued and needs to weaken. The real effective exchange rate of the rupee, which is the nominal effective exchange rate (a measure of the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs, was at 114.54 in August. The RBI has been selling dollars since the beginning of this year to support the currency as a result of which there is a minor dip in the forex reserves from its peak of $426 billion in April to $399 billion now. Overall, the RBI’s response to the rupee decline has not been very aggressive so far. Surprisingly, the central bank has been largely silent about the rupee fall as it doesn’t sense any crisis situation. No one, except some top government bureaucrats, has been making attempts to ‘talk up’ the rupee. Going ahead, the rupee will await global cues and, according to traders and economists, one cannot rule out the local unit testing 75 levels against the dollar. In other words, Rupee’s bad days aren’t over yet. As for Jaitley’s prescriptions, those are far too inadequate to cure the currency’s fever.