Rajan effect: Sensex, Re rally as RBI chief fuels confidence

The rupee rallied and shares surged on Thursday after the new Reserve Bank of India (RBI) chief unveiled measures to support the ailing currency, providing a shot of confidence for investors unnerved by the country's worst economic crisis in two decades.

But amid the euphoria over RBI Governor Raghuram Rajan's energetic Wednesday debut, investors warned he cannot by himself repair an economy mired by slowing growth and a record high current account deficit that has helped fuel a drop in the rupee of as much as 20 percent this year.

Rajan faces pressure from investors to roll back the central bank's controversial steps to defend the rupee by draining cash from the market and raising short-term interest rates at a time when investors are clamouring for ways to boost growth.

The government has struggled to push through politically tough reforms needed to fix the economy, and elections due by next May raise the prospect of expensive populist spending that could threaten the country's sovereign credit rating, which is one notch above junk status.

Finance Minister P Chidambaram said again that New Delhi would stick to its fiscal deficit target for this fiscal year, while repeating his oft-stated view that the rupee had fallen too far and was due to recover.

"This is a year of fiscal consolidation," he told parliament. "I have repeatedly said that the 4.8 per cent (of GDP), which we have estimated will be the fiscal deficit, is a red line. The red line will not be crossed."

On Thursday, however, scepticism was trumped by euphoria over Rajan, a prominent former chief economist at the International Monetary Fund, who unexpectedly unveiled a flurry of proposals in his first day at the helm of the central bank.

The rupee rose as much as 2.3 per cent to 65.53 per dollar, well off the record low 68.85 hit on August 28, when it was down more than 23 per cent from its 2013 peak. It ended trade at 66.01, compared to its close of 67.0650 on Monday.

The Nifty rose as much as 3.3 per cent, propelled by lenders such as HDFC Bank, which surged after new steps outlined by Rajan that included increasing overseas borrowing limits for banks. The BSE Sensex ended up 2.2 per cent and the Nifty gained 2.7 per cent.

The new measures to prop up the rupee included providing exporters and importers with more flexibility in hedging their forward currency contracts, as trading firms had long complained about regulation that left them unable to quickly cope with rapid currency movements.

Rajan also announced plans to offer forex swap lines at below-market rates for banks raising deposits from Indians abroad. Bankers estimate those measures could attract about $15 billion in additional funds over the next three months.

"Rajan means business, but most of his measures are just statements of intent, especially in the light of government finances being so precarious," said G Chokkalingam, chief investment officer at Centrum Wealth Management.

Rajan faces difficult decisions ahead, including navigating uncertain global conditions marked by rising military tension over Syria, which is pushing up India's oil import bill, and the prospect of an end to US monetary stimulus.