The set of initiatives unveiled by the government/RBI last weekend to address the flailing rupee indicates that they don’t seem to realise the kind of damage a market in full flight can do. Unlike the electorate, which can sometimes be taken in by rhetoric and muscle flexing, the market is unforgiving and strong enough to create serious damage to any economy.
The initiatives, which, provided nothing to improve the immediate supply/demand imbalance, had, unsurprisingly, no impact on the market. Tinkering with bond investment limits, reducing the permissible tenor of borrowings and tweaking the withholding tax on masala bonds may all be sound policy, but in terms of addressing the issue in question—viz., increasing the immediate inflow of dollars—they add up to a big fat zero. Worse yet, the plan to impose tariffs on certain items to reduce the current account deficit is counter-productive to strengthening the economy and, in any case, would take time to bear even what withered fruit it might.
Certainly, the widening current account deficit is an important concern, although, in reality, it simply reflects a strong domestic economy and a strong rupee. Rather than erecting barriers to trade—even though that appears to be the flavour of the times—the resolution is to let the rupee slide (as is happening) and, critically, focus on building exports, which has been a singular failure of this—and previous—governments.
Rather than this loudly-heralded nothing, prudence would have suggested an off-policy interest rate hike as soon as the rupee crossed 70, which was a very long month ago. While it was discussed, there were concerns that this would “nip the incipient animal spirits in the bud” and signal panic to the market. In the event, not having made that attempt to draw a line somewhere has led to a sharp (and continuing) decline in equities and continued nervous panic in the FX market. Two weeks ago, the question was whether the rupee will reach 72; today, nobody will venture a guess as to the possible bottom.
The winds may abate, of course. That is the nature of markets and the weather—you never know when things will turn. But, as any disaster management team knows, it is infinitely better to be too conservative and wrong than to be too laissez faire and wrong.
To be fair, RBI has been intervening to prop up the rupee since late April, when it threatened the 69 level for the third time since the 2013 taper tantrum. However—third time (un)lucky, I guess—when it broke through 69 in early August, RBI appeared to give up the ghost, doubtless hoping that the decline would run out of steam without creating too much panic.
However, this seemed to embolden market speculators—the average spread between the NDF market and onshore market for 1 month forward, which had been running at around 14 paise since July, shot up to 24 paise once the rupee broke below 70, with a peak spread of 52 paise (as compared to 32 paise before that).
Clearly, the paradigm has changed and, as mentioned earlier, an out-of-turn rate hike may have given the market some pause. There is still a bit under two weeks left for the next MPC (October 3), and if the rupee once again threatens 73, as it has much of this week, RBI should push the off-meeting button. Rather than creating panic as had been feared, this will signal that RBI is engaged and recognises the trauma that has already been precipitated. Of course, even this may not be enough.
Given that US rates are sure to rise further over the next several months, global dollar liquidity will tighten, which could well bring renewed pressure on the rupee. While the tried and tested props—a special window for oil companies to buy dollars, an NRI bond issue—are available, the lesson of the past month is that the timing of their announcement is key.
Another idea that could be implemented quickly would be to offer PSUs (like IRFC, PFC, SIDBI, IREDA and others), many of whom have large undrawn FX lines of credit from multilateral institutions, a dollar deposit window at a rate somewhat below that which would have to be offered to NRIs. These lines, which could add up to over $15 billion, are not yet drawn since the companies do not have assets to match them with just yet. They could park these with the government, and use the deposits as collateral for subsequent rupee borrowings to fund assets as they come on stream. Difficult times—pray that it doesn’t turn into a disaster.
The author is a CEO of Mecklai Financial