Can the rupee slide be stopped?
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Can the rupee slide be stopped?

India’s economy and currency has taken a battering, yet the worst of rupee depreciation should now be behind us. Stability should return, though a more meaningful appreciation of the rupee is still some distance away, writes Sanjay Mathur, Managing Director and Head of Economics Research, Asia Pacific ex-Japan at RBS.

Sanjay Mathur, RBS Chief economist, non-Japan Asia
Sanjay Mathur, Managing Director & Head of Economics Research, Asia Pacific ex-Japan

The Indian currency has been the worst performer in Asia so far this year – plummeting to record lows against the US dollar – the stock market fell 10 per cent in a month and bond yields have surged as investors took fright. The slide in India’s markets are part of a wider exodus of foreign capital from emerging markets prompted by news that the US Federal Reserve is considering scaling back its bond-buying stimulus. That has raised concerns about India’s ability to finance its current account deficit and prompted Prime Minister Manmohan Singh to insist the country had adequate currency reserves and was not heading for a crisis.

The irony is that the Indian government has been implementing a raft of measures to address this very issue. Three important developments in June and July point to a more stable future for the rupee.

First, efforts to slim the trade deficit by slowing precious metal imports have shown early results. India’s trade deficit narrowed to USD12.3 billion in July versus an average USD17 billion in the previous six months, after the Reserve Bank of India (RBI) introduced measures to restrict gold imports. Import financing for gold and gold imports by trading houses (above that needed by jewellery exporters) are restricted. These measures follow a ban on margin financing for gold imports and the further raising of import tariffs, which are likely to be felt from September.

Second, the RBI has tightened domestic liquidity. To curb the supply of rupees and shore up the currency’s value, it raised the marginal standing facility and upped bank rates, capped cash injections into the banking system and increased the banks’ daily minimum cash balance requirements. At the same time, it has managed to discourage speculators by raising the carry-adjusted return over the US dollar. This tightening of liquidity appears in-line with previous IMF prescriptions for countries facing an external crisis.

Third, India has introduced a host of measures to encourage foreign direct investment (FDI) — a key policy of the government since coming to power in 2004.

Regulations on external commercial borrowing have been liberalised and local subsidiaries of multinational corporations can now borrow freely from their parent companies. Stateowned oil companies will also have access to external borrowing, while state-owned infrastructure finance companies are being encouraged to borrow overseas.

Such inflows are likely to increase thanks to the complete deregulation of the rate charged on deposits made by non-resident Indians, making them more attractive by shifting the exchange rate risk from depositor to the bank in which the money is deposited.

While inward foreign investment in India is encouraged, outflows are being discouraged. The government must now approve overseas FDI by Indian corporates and at the personal level, remittances flowing out of India have been capped. Indian residents will also no longer be allowed to buy overseas properties.

The government hopes all these measures will restrict the rise in capital flows to USD11 billion, or 0.6 per cent of GDP, bringing down the current account deficit and stabilising the rupee.

India may still struggle to hit a current account deficit target of 3.7 per cent of GDP this financial year as monetary tightening coincides with already weak growth. However, there is a better demand-supply balance in the rupee that should help the currency stabilise in the immediate term.

The trade deficit is narrowing, liquidity conditions have been tightened and the problem of gold imports is being dealt with on a dynamic basis. The most important change is in the policy mindset – rupee stability has taken precedence over all other objectives.


A version of this article appeared in Bloomberg Brief, Economics Asia on August 29, 2013

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