India makes risky bet with rupee defense

India makes risky bet with rupee defense

12:22pm EDT

By Rafael Nam and Subhadip Sircar

MUMBAI (Reuters) – India’s boldest attempt yet to prevent a rout in the rupee delivered only a modest lift in the currency but shares slumped and bond yields jumped as investors worried that policymakers might overplay their hand and damage economic growth. The government said on Tuesday the moves were an attempt to stabilise the currency, which hit a record low last week and is down nearly 10 percent since the start of May. Analysts say longer-term economic reforms are what India really needs.

The measures unveiled Monday night in a rare display of tactical force by a conservative central bank would make it harder to speculate in the rupee and are intended to attract foreign inflows needed to fund a record current account deficit.

They also increase the possibility that the Reserve Bank of India’s next move on policy interest rates will be a hike.

“We think that the measures, in effect, constitute a shift in monetary stance from pause to tightening,” Goldman Sachs economist Tushar Poddar wrote in a note, putting the odds of a rate hike at the RBI’s policy review on July 30 at one in three.

The RBI raised short-term borrowing costs, restricted funds available to banks and said it would sell 120 billion rupees ($2 billion) in bonds, effectively draining cash from the market, to protect a rupee that hit a record low last week.

The steps are risky and expected to be temporary, with Standard Chartered Bank saying they could only be maintained for up to six months.

“The best case, or what we are all hoping for, is that these are short-term measures purely to drive home a point, that it does not endanger growth in the long term,” said Ananth Narayan, co-head of wholesale banking for South Asia at Standard Chartered Bank.

The moves will raise funding costs for banks and companies almost immediately, creating a ripple effect that could crimp growth in an economy expanding at its slowest in a decade.

In a direct response, Bank of America-Merrill Lynch cut its GDP forecast for Asia’s third-largest economy to 5.5 percent from 5.8 percent for the fiscal year ending March 2014.

The rupee strengthened to 59.43/44 per dollar on Tuesday from a close of 59.89/90. Last week, it fell to a record low of 61.21.

Montek Singh Ahluwalia, deputy chairman of the government’s Planning Commission told TV channel CNBC-TV18 the measures would be reversed when rupee stability was restored.

And Finance Minister Palaniappan Chidambaram said they should not be seen as a signal of a change in policy rates.

“These measures are intended to quell speculation or excessive speculation in the forex market, trying to reduce volatility in forex market,” Chidambaram told reporters.

In a further move to attract foreign investment, India late on Tuesday eased foreign direct investment rules in sectors including telecoms, defense, insurance and single-brand retail. Prime Minister Manmohan Singh in a meeting with senior cabinet members cleared a proposal to allow full foreign ownership of local phone carriers, now capped at 74 percent.


The RBI’s next policy decision is on July 30 and the predominant expectation is it would leave rates on hold for the second consecutive review, after cutting them by a combined 125 basis points since April 2012 in an effort to revive growth.

If the RBI’s measures to support the rupee fail, it could force the central bank to reverse course and raise rates, a measure taken last week by Indonesia.

Benchmark 10-year bond yields surged as much as 54 basis points on Tuesday to their highest since late December, and short-term rates also jumped.

As bond yields surge, India risks making higher borrowing costs harder to reverse, unless they are accompanied by steps to narrow the current account deficit from a record 4.8 percent of gross domestic product in the last fiscal year.

Stocks fell, dragged down by lenders that rely on short-term funding, with Yes Bank (YESB.NS: Quote,ProfileResearchStock Buzz) down nearly 10 percent and IndusInd Bank (INBK.NS: QuoteProfile,ResearchStock Buzz) down 8 percent.

Continued losses in the stock and bond markets could spark more foreign outflows. Overseas investors have already sold around $11 billion worth of debt and stocks since late May.

The RBI has been reluctant to intervene aggressively by dipping into foreign currency reserves that cover nearly 7 months of imports, as any rundown of its holdings could further erode foreign investor confidence.

Regulators have instead tried to clamp down on speculative trading by focusing on onshore derivative markets.

Nomura economist Sonal Varma said the latest moves could backfire.

“India’s growth is already very weak and tighter domestic liquidity will worsen the financial conditions for corporates and banks, hurting asset quality and the growth outlook,” she said in a note.

“The probability of a rate hike, if today’s measures are not successful in stemming rupee depreciation, has gone up.”

July 16, 2013, 1:09 p.m. ET

India Faces Dilemma in Shoring Up Rupee

Central Bank Seeks to Counter Outflows, Without Hurting Growth


India’s central bank is walking a tightrope—trying to arrest the rupee’s sharp decline as global capital flows out, without raising interest rates in a way that could slam growth.

India’s economy is growing at its slowest pace in a decade, and higher rates could choke off an acceleration expected later this year. On the flip side, policy makers are unnerved by a record-breaking slide in the rupee that threatens to pump up import prices.

Late Monday, following sporadic foreign-exchange market interventions and tighter trading rules, the Reserve Bank of India set a limit on the amount banks can borrow from the central bank at the benchmark interest rate of 7.25%. Above that limit, banks would have to pay much higher interest.

The RBI also said it would sell 120 billion rupees ($2 billion) of bonds Thursday, on top of a scheduled 150 billion-rupee bond sale Friday, in an effort to drain funds from the banking system.

The efforts helped the rupee pick up to its highest point in two weeks. But economists fear these steps could end up hurting the rupee if foreign investors conclude economic growth will suffer, and sell Indian assets.

“They are trying to do the right thing, trying to make it expensive to [sell] the currency, but there can be a cost to pay in terms of growth,” said Bhanu Baweja, a UBS UBSN.VX +0.24% currencies analyst in London.

In the short term, investors bought the rupee, pushing the dollar down to 59.17 rupees, analysts said. In late trading in New York on Monday, the dollar was at 59.32 rupees. But the currency has had a tough run. The dollar rose to 61.21 rupees on July 8, and the rupee and is down 9% against the greenback this year, making it one of the worst performers in Asia. India depends heavily on imports for commodities such as crude oil, so a weak rupee stokes inflation.

Expectations that the U.S. Federal Reserve will soon begin winding down a bond-buying program that has flooded global markets with liquidity has prompted outflows from most emerging markets in recent months.

With India dependent on foreign money to fund its current-account gap—which reached a record 4.8% of gross domestic product in the year ended March 31—the recent outflows from emerging markets have hit the rupee especially hard.

“Currencies associated with current-account deficits will be at the mercy of global capital flows,” said Siddharth Mathur, head of Asia FX and local markets strategy atCitigroup

C +0.04% in Singapore.

The RBI’s efforts mirror steps by other governments to protect their currencies by tightening monetary policy. The central bank of Indonesia—another Asian tiger with a significant current-account deficit— raised its benchmark rate and a key money-market rate by half a percentage point last week, sacrificing growth prospects in an effort to protect the rupiah. Turkey’s central bank has said it might raise rates as soon as next week, while Brazil has boosted rates three times this year.

“We have to expect more efforts from emerging-market central banks to defend their currencies,” said Murat Toprak, a currencies strategist at HSBC HSBA.LN -0.60% in London.

The RBI raised rates by 3.75 percentage points between March 2010 and October 2011 to tame inflation. Since April 2012 it has cut rates by 1.25 percentage points to support growth.

High interest rates, a weak external environment and a large fiscal deficit have taken a toll on India. The economy grew 5% in the year ended March 31, well off its 9% pace two years ago. On Tuesday Bank of America-Merrill Lynch cut its forecast for Indian economic growth this fiscal year to 5.5%, from 5.8%.

Some analysts praised the RBI’s strategy of increasing short-term borrowing costs for banks without raising the benchmark rate.

Rupa Rege-Nitsure, chief economist at Bank of Baroda 532134.BY -4.35% in Mumbai, said an increase in benchmark rates would have sent the message that the RBI wanted to tighten credit in the middle of an economic slump. Monday’s rate tweaks, some analysts say, will tighten credit conditions only if the RBI persists with this policy for several months. Most banks in India don’t depend heavily on wholesale funding to make loans so it will take a while for the higher short-term costs to transmit.

Monday’s steps come after other measures to bolster the rupee have had limited success. Last week the RBI barred banks from buying or selling exchange-traded currency derivatives for their own accounts, while India’s securities regulator made it more expensive for investors to trade in currency derivatives.

The RBI also has been selling dollars sporadically to prop up the rupee, but hasn’t mounted a truly spirited defense—possibly because India’s foreign-exchange reserves, at $280 billion, can’t fund even seven months’ worth of imports.

That leaves the central bank searching for answers as events beyond India’s borders batter the rupee.

“We are not witnessing a run on currencies. The issue is that the global capital cycle has turned the corner and flows are heading home, and currencies that do not enjoy the support of a large current-account surplus will feel the pinch more than others,” Citigroup’s Mr. Mathur said. “Central banks are trying to counter this, but it’s more about the signal. They can signal that any speculation on top of the real capital flows is unwelcome. This is the message.”


About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (, the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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