Out-of-step rupee and a fistful of solutions

A fortnight ago, the rupee touched an all-time low of 61.21 to a dollar. After waiting and watching the fall for a week, the Reserve Bank of India took some decisive steps to support the currency, as a result of which the rupee jumped a little over one per cent. A welcome beginning, though what perplexed economists, analysts, market watchers and investors was that the Indian currency could not retain its sheen for a long time and shed most of its gains in a couple of days. The government reiterated that the fundamentals of the Indian economy are strong but the foreign exchange markets refuse to listen.

Why then are the measures by RBI not working? Has the central bank been too late to respond to the problem and are market sentiments responding accordingly, or does the problem lie elsewhere?

The RBI raised the marginal standing facility rate or MSF and the bank rate each by 200 basis points to 10.25 per cent. MSF is the rate at which banks can borrow from the RBI at an elevated rate against government securities during times of tight liquidity. Under MSF, the banks used to borrow money at the repo rate plus 1 per cent, which was equal to 8.25 per cent. But now, the MSF stands 300 basis points above the repo rate which is 7.25 per cent.

Secondly, the RBI capped total funds available under its repo window at 1 per cent of bank deposits. The overnight borrowing limit now stands at Rs 75,000 crore for the entire banking system. And, thirdly, it announced a Rs 12,000 crore sale of government bonds to suck out liquidity from the system.

Right remedies?

It took measures to make it unattractive for banks to borrow the rupee at cheap rates, prevent speculation in the money market and bring stability to the rupee to bring about temporary relief from the rapid slide of the rupee against the dollar.

But the immediate fallout of the measures was that of bonds falling by about Rs 5 and yields on these soaring, while the dollar-rupee exchange rate moderated very little. The treasury bill auctions and bond sales by RBI fell well below their intended target. The health of the money market did not recover much which led to many an eyebrow being raised on whether the central bank was really interested in addressing the problem.

Some in the government said that it takes time for such measures to be implemented and take proper shape, but others outside government are of the view that these measures should have come within the first week of the slide of the rupee against the dollar. They said the RBI’s move increases the risk of interest rate hikes even as economic growth is currently at its lowest ebb in the past decade.

As a consequence of the central bank’s measures, brokerages and banks cut their India GDP forecast for 2014. According to analysts, the RBI's measures to arrest the rupee fall will work only if there is a parallel plan in place to solve the structural issues plaguing the economy. These include the strength or weakness of a country’s imports and exports, inflation, unemployment rate, interest rates, growth rate, trade deficit and current account deficit. On all accounts, India is vulnerable at this point in time.

But, India also has more immediate problems on its hands that are weakening the domestic currency. The RBI needs to bring them in check, according to Aman Agarwal, Vice-Chairman and Professor of Finance at the Indian Institute of Finance. Agarwal sees the upcoming elections in India bringing in huge amounts of foreign funds into the country to finance them, thus adding to the risks of rupee depreciation.

Free-float

He argues that the Indian currency holds huge potential to move back to levels of Rs 50 against the dollar if it is allowed to float freely in the short run, say, the next two months. But the government and the RBI should be willing to do that.

“If the RBI and the Ministry of Finance keep playing their cards to keep the fiscal deficit in control and have the RBI's balance management done, the rupee would slide further down to a level of Rs 65 to a dollar,” Agarwal said.

He sees the exporter lobby working behind the rupee fall. According to him, the lobby would like to bring its funds — often maintained in US dollars or Euros — back to India so that it can paint its quarterly results as positive, especially in a situation where industrial production figures are not on the bright side.

RBI and the government need to be more forthcoming to ensure that the rupee attains its desirable level, most economists contacted by Deccan Herald said. The rupee is a reserve currency for countries like Mauritius, Nepal, Bangladesh, Sri Lanka and others with whom India has strong trade relations. Not to mention the fact that the BRICS bloc of nations have emerged strong on the trade front as well as in realigning their financial policy framework to the benefit of the bloc, clearly signalling a go-ahead for the rupee to regain lost strength.

If the rupee gets to the 65 mark, India’s oil bill will be adversely impacted. India is a net importer of oil and close to 80 per cent of its domestic oil requirements come from abroad. A rising oil bill will muddy India’s deficit numbers and deter all government efforts to improve them. Given that India is heading into an election year, whether the government will be interested in finetuning the fundamentals of the economy to get back to growth mode or target only short-term economic goals is anybody’s guess.