Mitul Kotecha, head of global markets research Asia, global head of foreign exchange strategy
The Indian rupee has been the worst-performing Asian currency. Clearly this has caused a great deal of consternation among the authorities in India, leading to a plethora of measures to stem the decline in the currency. Such measures include providing dollars directly to state oil companies, limits on gold imports, encouraging foreign investment in infrastructure, raising limits on foreign direct investment (FDI), reducing resident foreign exchange outflows, and making it easier for companies to borrow overseas.
While the dollar demand/supply imbalance has been reduced due to recent measures the problem for India is that underlying issues – namely structural economic weakness, and gaping current account/fiscal deficits – will not improve quickly. Unfortunately India is reliant on foreign capital to plug the current account gap. As US Federal Reserve (Fed) tapering fears have intensified and US bond yields have increased this leaves the rupee particularly vulnerable, as both equity and bond flows have reversed sharply.
Regaining investor confidence will be crucial to entice capital flows. This will require robust and credible reforms that are not only passed but are also seen to be implemented. Given looming elections by early next year this will be a tough task. The government will be highly tempted to pursue populist polices to gain votes. For capital inflows to resume investors need to be convinced that the growth trajectory will improve, but even with reforms it could take years to remove many structural impediments to growth.
In the interim much will depend on an improvement in the external environment. A generalised improvement in risk appetite globally will help steady nervousness towards emerging markets and India in general. However, the rupee is the most highly correlated Asian currency to US bond yields and the prospects that US yields will continue to rise, suggests that pressure on the currency will not ease quickly.
Indranil Sen Gupta, India economist
Bank of America-Merrill Lynch
We believe that the Reserve Bank of India (RBI) will have to recoup foreign exchange (FX) reserves to stabilise the rupee.
After all, import cover has halved to about seven months – last seen in 1998 – well below the eight-to-10 months critical for stability. India's balance of payments indicators have now begun to trail Bric (Brazil, Russia, India and China) levels.
Not surprisingly, the rupee has been amongst the hardest hit in the present round of FX volatility. Reserve Bank of India (RBI) governor Raghuram Rajan has taken the first step to recoup FX reserves by offering concessional swap lines to banks that raise FX-denominated deposits from non-resident Indians under the Foreign Currency Non-Resident (FCNR) scheme. Looking ahead, we expect the government to issue sovereign debt to add to FX reserves.
The government and the RBI are also taking steps to rein in the current account deficit by curtailing gold imports. We expect the current account deficit to come off to 4% of GDP from 4.8% last year. In our view there is a limit to which this deficit can come down in our world of low global growth – limiting exports – and high G3 liquidity – pumping up the oil import bill. In our view countries like India will likely have to live with high current account deficits until the global economic cycle turns around in 2015.
India will also have to address structural bottlenecks to speed up recovery. At the same time, revival of capital expenditure (capex) will likely have to wait till the 2014 summer elections. In fact, political uncertainty will likely add to the challenge of attracting capital inflows till the general elections.
Radhika Rao, economist
India’s authorities have been busy since the domestic markets went to into a tailspin from late May 13, when the rupee fell more than 20% against the US dollar. In this regard, the recent appointment of the new RBI governor provided a much-needed breather to the markets.
Moves to ensure that official communication is consistent and predictable is a step in the right direction, helping the markets find some degree of confidence. Beyond this, one asks what can be done to right the wrongs? The action plan entails both short-term and long-term fixes.
In the short-run, moral suasion and active FX intervention will help buy time. Other measures include limiting net overnight open positions, stipulating export receipt conversions, offshore bond issuance or currency swap arrangements with major central banks. A hike in the repo rate is also a possibility, but the negatives may outweigh the positives. The equity-focused nature of foreign investors and potential downside risks to growth lower the odds for an imminent rate hike.
Nonetheless, the timing will be dictated by the severity of the rupee correction. Despite the line-up of measures, the influence of external developments on the currency has been notable. Hence, these measures will help manage the pace of depreciation, rather than reverse the tide. It is realistic to assume then that capital inflows will be slow to return in the next eight to 12 months. Elections weigh on the ultimate direction of flows.
Longer-term, external deficits need to be shrunk.
As a sign of rising vulnerability, gross capital flows jumped from 33.4% to GDP in 2000-2010 to 46.4% last year. With the current account deficit widening from -0.5% of GDP to 4.8% in the same period, rupee weakness is easy to explain.
Hence, relevant policy changes should be focused on scaling back the import bill (fiscal austerity ties in) accompanied by exports recovery, to bring a sustainable turnaround in the current account. Growth will enter a soft patch in the interim as the central bank has little room to provide policy stimulus, while the upcoming elections cloud the outlook for regulatory initiatives.
Only when the growth outlook brightens on a revival in domestic investment activity will foreign capital buy into India again.
Priyanka Kishore, FX strategist
The new RBI governor has started on the right note by announcing a series of measures to support the rupee on his first day in office. This should reinforce the positive rupee sentiment that was visible following the announcement of the FX swap facility for select oil marketing companies on August 28.
Of particular note are the concessional FX swap facilities for the additional US dollars raised under the FCNR schemes and the new overseas borrowing limits
for banks – 100% of Tier I capital as opposed to 50% earlier.
Together these steps could generate US$10 billion-US$15 billion additional inflows into India and play an important role in reducing current account deficit financing concerns; given that the current account is already improving. Equally important is the RBI’s decision to provide corporates greater access to the FX market for risk management.
This underscores governor Rajan’s intent to add to the depth and breadth of the onshore market, and is a welcome development as much of the rupee’s recent choppiness could be attributed to lack of liquidity in the FX market.
However, these steps need to be viewed against the challenging global backdrop which continues to pose downside risks to portfolio flows. The debate on Fed tapering and ongoing geopolitical concerns supports the case for broad US dollar strength, keeping US dollar-Indian rupee rate vulnerable to upside risks. Hence, the policymakers cannot rest on their laurels yet.
While key reforms to revive investment are unlikely in the near future due to the approaching elections, there are some low-hanging fruits which should not be ignored. Proposals to establish swap lines with other central banks, to lower the oil import bill and issue more quasi sovereign bonds should be actively pursued to rebuild investor confidence in the rupee.