Samir Gilani

The intent of this analysis is to decipher the rationale behind RBI?s recent regulation to stem the rupee volatility and to establish whether these measures could potentially open up a few positives (beyond a support for the rupee) for us in the near term. I believe that the benefits of steps taken by RBI will be visible in some time and that RBI could perhaps tweak some regulations to achieve its goal, at the same time balance expectation of the stakeholders. I also believe that RBI anticipates that the recent measures taken will result in the following:

(a) Abate the selling in the bond market (which was perhaps one of the factors that led to the rupee fall) by giving FIIs a better yield and not giving them another reason to exit India especially when yield differentials between Indian debt and developed market bonds have been coming down.

(b) Make external commercial borrowing (ECB) for Indian corporates more attractive than domestically available as hedging and borrowing cost works out to 8.5% currently.

It is reasonable to expect that the recent measures announced should spur FIIs to buy Indian bonds, where yields have inched from 7.15% to 8.4% in less than a month. However, what should be investigated is whether FII inflows into bonds or equities results in appreciation or stabilising of the rupee?which is the ultimate goal of the central bank. The accompanying figure shows net debt and equity investment by FIIs on a yearly basis to determine if inflows or outflows have any significant bearing on the rupee.

An interesting trend is observed from the data. During 2003-07, strong FII inflows in debt/equity resulted in the currency appreciating. However, from 2011 onwards, even record inflows in equity plus debt did not result in the rupee appreciating. What could be the reason for this? In 2003-04, our current account was positive, reaching the best surplus at $7.36 billion in March 2004. Between 2005 and 2007, our current account was on average $5-7 billion in deficit. It was after 2011 that our CAD turned extremely negative with the worst deficit at $32.63 billion in quarter to December 2012.

The recent measures taken by RBI could boost debt investment by FIIs, but for this to be effective our deficit numbers will need to sharply come down. RBI has already taken measures on this front by curbing the imports of gold and this has helped our deficit for now?currently at $18 billion.

I believe that RBI has taken the right steps?firstly, by controlling the gold import bill and now setting up a mechanism to ensure flow of money into our markets. The measures could bear fruit but it will take a while before we see a meaningful difference. In the meantime, a more effective and short-term measure would be to tweak some of the ECB guidelines. The ECB market might help to reduce the liquidity pressure on Indian corporates.

Currently, ECB is allowed mainly for capital expenditure towards new projects and capacity expansion but cannot be used for working capital, general corporate purposes and repayment of existing rupee loans. RBI can look at the ECB market to further help achieve its goal of containing the rupee volatility.

RBI action might seem harsh to many at this point in time but I feel that they are aligning elements and policies in such a way that the benefits of the same will be visible to everyone over a period of time.

The author is head of Trading, IDFC securities. Views are personal