RBI steps in to bolster sagging rupee and attract more foreign flows

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Further, FPIs can now invest unlimited amounts in under one-year maturity bonds. This is an effective step because currently FPIs are allowed to buy only bonds with over one-year residual maturity and the FPIs sell off when maturity dips below 365 days. This selling will stop now. Indeed fresh dollars may come looking for yield arbitrage.

Thirdly, banks raising foreign loans have been given wider options to lend the money. Hitherto they could only lend to exporters. Finally, companies can now raise ECBs (External Commercial Borrowings) up to $1.5 billion via the automatic route, up from $750 million earlier. While this is a major easing of doing business, bankers say companies may not raise too much money till the global macros stabilise.

——————————————————————————————————————                               RBI's Salvo To Prop Rupee

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These steps have obviously come because the rupee is sliding to fresh all-time lows practically every day in the past two weeks. Separately, the country's trade deficit has also been burgeoning due to pricier crude and coal imports raising fears that the deficit can be funded only by the rapid depletion of reserves.

RBI argued in its press release that the Indian economy is resilient but the tightening by foreign central banks is having spillover effects on all emerging markets (EMs) including India. It pointed out that the rupee has depreciated only 4.1 percent this year which is much less than many EM and even DM currencies. (The Euro and the Yen, for instance, are trading at 20-22 year lows). However, it is announcing these steps to ensure greater foreign inflows, so as to counter the impact of volatile global markets which are leading to outflows from all EMs.

Also Read: RBI retains India's growth projection at 7.2% with first quarter expectation at 16.2%

Bankers agree that with no caps on the interest they can offer on FCNR(B) and NRE deposits and the added advantage of no CRR and SLR requirement, they will aggressively seek investors into these deposits. Bankers also expect foreign funds to be attracted to short-term Indian corporate papers.

More important, funds will hedge the new inflows through sell-buy swaps in the forward market. The increase in buy calls in the forward market will enable RBI to do sell-buy swaps in the forward market to protect against any rupee fall. In the past few weeks, RBIs excessive sell-buy swaps in the forward market led to the crash of the forward premiums, which in turn attracted speculative shorting in the spot market.

Besides bringing inflows, this sudden announcement will also impact sentiment. This sudden salvo will bleed those with short rupee positions and they will desist from further speculative shorting, for fear that RBI may fire more steps.

Some experts believe the RBI may be over-reacting and that rupee depreciation has been orderly and much less than other EM currencies. However, RBI probably wants to be sure than sorry. The rising trade and current account deficits need to be financed and speculators needed to be kept at bay, lest sentiment gets unhinged.

With oil also receding sharply for the past week, it now appears that the level of Rs 80 against the US dollar is a distance away, On the flip side, this level of Rs 80 against the US dollar shouldn't become an albatross around RBI's neck — a level it will defend at any cost.