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Asia CommentGC Asia View

Steady does it for rupee internationalisation

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The Reserve Bank of India recently eased rules on rupee denominated loans as its takes tentative steps to internationalise the currency. Critics have found fault with the pace of change, but the central bank is right to take it slow as the country has plenty of work to do to make sure its economy is in a stronger position before there can be a pick-up in the pace of reform.

In the latest of a series of moves aimed at making the rupee a more internationally tradeable currency, the Reserve Bank of India has allowed foreign lenders to extend rupee loans without first entering into a swap transaction with an Indian bank, as was the case before.

Offshore lenders can now enter into a swap with an international bank, which will then enter into a swap with an Indian bank. This simplification of rules is designed to encourage lender interest in rupee denominated offshore borrowing,

The easing follows the recent introduction of what are commonly called masala bonds — rupee debt issued offshore. International Finance Corp debuted the format last November and the RBI has since expanded the plan to Indian corporates. 

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Increasing the amount of rupee denominated debt will have big benefits for India as currency risks will shift from Indian borrowers, reducing the exposure to foreign currency debt and the associated hedging and conversion costs. This is a sensible plan, considering this year’s dollar strength and the expected US rate rise.

In an environment where high grade borrowers in Asia are offering a yield of just 100bp-150bp over Libor for dollar denominated borrowings, the prospect of an 8%-10% return on rupee denominated debt looks tempting.

The strength of the rupee, and by extension, the country, is going to be key in determining how investors react to its attempts to internationalise its currency. Headline numbers look promising, with GDP growth coming in at 7.5% for the first three months of the year, outperforming China’s 7%.

However, for overseas investors to feel confident enough to take a view on the local currency, the country has plenty to do to make sure to its house is in order.

Critical journey

As a net importer of oil, India has benefited hugely from the decline in price of the fuel, resulting in a lower current account deficit and a fall in inflation. But while welcome, the improvement in its fiscal position is an outcome of external factors rather than domestic policies.

How sustainable this improvement in fiscal position is going to be is critical in the journey towards making the rupee more freely tradeable. But the RBI alone cannot drive the country towards that stability. This needs commitment on the governance front as well.

Delhi has a long to-do list, including shoring up its revenue stream, reducing the subsidy burden and ushering in crucial reforms related to acquisition of land, as well as moving forward with much needed infrastructure projects.

It also needs to make it easier for foreign investors to deploy capital in the country — something that its neighbour to the east is experimenting with in its own efforts to internationalise the renminbi.

India's ambitions are not nearly as grand as China’s in terms being a major reserve currency, but the end goal is seen as India’s full capital account opening, for which the country must show long term and consistent fiscal discipline.

India has plenty to gain from opening up its currency. But it has plenty to lose too if fiscal improvements are slow to be enacted.

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