RBI and Indian Government Measures for Stopping the Rupee Free Fall

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IS 70 THE NEW 60?

On Sept, 19 Indian Rupee plummeted to the record low of Rs.72.97; the primary reason for such a fall has been the meltdown of the Turkish Lira and Argentine Peso. It has spurred the govt. into action to stop this freefall.

India’s current account deficit deteriorated from .06% of the GDP in the FY17 to 1.6% in the FY18. It is projected to hit the 2.8% mark this current year (FY19). The trade deficit has widened to $80.4 billion in the first five months of the current fiscal year (Apr-Aug) from $67.3 billion in the same period last year.

The trade deficit has widened over time

The bottom line to the strengthening of the rupee is Dollar inflows. India has the sixth biggest dollar stash in the world hovering around $400 billion but the situation warrants more. In fact, in the first five months, the reserves have fallen by $18 billion approximately.

To curb the rising current account deficit; Since July the govt. started to increase the customs duty on a host of goods such as inputs used in mobile phones and other hardware, watches, fruit juices etc. These measures weren’t effective as goods were being routed via countries with which India has free trade agreements (FTAs). With Polls just around the corner, they were compelled to take action to arrest the weakening of the rupee. Recently, the government has announced a five-pronged strategy to stop the rupee from further depreciating-

  • Easier External Commercial Borrowings (ECBs) – External commercial borrowings are loans in India made by non-resident lenders in foreign currency to Indian borrowers. They are used widely in India to facilitate access to foreign money by Indian corporations and PSUs. The government wants to make these ECBs easily available for manufacturing companies; Capped amount being $50 million. This strategy aims to improve the investor sentiment and supply of dollars
  • The Masala Bond Push – Masala Bonds are rupee-denominated borrowings issued by Indian entities in overseas markets. The term “Masala” means spices was used by the International Finance Corporations to popularize the Indian Cuisine. The objective of these bonds is to fund infrastructure projects via borrowings. The investor directly takes the currency risk as the bonds are pegged to the Indian Rupee. The government has exempted masala bonds from withholding tax and the Indian banks have also been allowed to underwrite the debt and be market makers. This has been done to bring inflows in the long term and also make these bond attractive. The dollar inflow in terms of borrowings actually strengthens the rupee.

    External Factors such as US sanctions on Iran, Trade War, Meltdown of Turkish Lira and Argentine Peso have had a huge toll on the Indian Rupee
  • No Hedging For Infrastructure ECBs – The government has disallowed the mandatory hedging of the borrowings which reduces the cost of borrowings but at the same time exposes the borrowers to losses if the currency weakens. This will reduce the dollar demand thus bringing the much relief for the Rupee in the short term. It will also ensure that there isn’t excess demand for dollars in the market.
  • Review of FPI Exposure limits– To bring in fresh debt investment the government has decided that it will review the exposure limits of the foreign Portfolio investment under which no FPI’s 20% or more of the corporate bond portfolio can be invested with a single corporate group. Another covenant up for review is that 50% of a single issue cannot go to any such group. This will create room for FPI inflows.
  • Fiscal Commitment–  The government stated that it will remain committed with the Fiscal deficit target of 3.3% of GDP so that it can keep a check on its spending which might widen the Current Account deficit.

Other Weapons available in the armory-

If the above options fail to provide relief the government can opt for Instruments like NRI BONDS. NRI bonds are forex deposits raised from Non-Resident Indians at attractive rates for 3-5 years with some lock-in period and RBI guarantee. According to a report by Meryl Lynch, these can help the government to raise around 30-35 billion USD in the December quarter.

Another option that the GOI has in its disposal is that it can impose minimum import prices or safeguard duties on some non-essential items. It is different from normal duties in the sense that it is applicable to even countries with whom the country has the FTAs signed so it would stop all the Rerouting of goods.

Duties on Nonessential Goods are having no effect as they are being rerouted through countries with which we have FTAs

Conclusion

The economic situation is similar to Rupee’s 2013 record crash where the rupee had breached the 66 mark under the UPA government which led to a host of reforms including the introduction of the Masala bonds. Economists are divided on the Government’s plan to arrest the freefall. Some believe that it will improve the Investor sentiments significantly and it is just what the economy needed while others believe that it’s a knee-jerk reaction because the macro Fundamental are in a better shape than in 2013- higher growth rate, stable inflation and an optimum fiscal commitment; So such a plan gives the impression to the investors that the government is panicking and they should withdraw their capital thus leading to a Capital Flight. Only time will tell whether it’s the correct course of action or not.