View: Rupee rebound was more due to fall in crude than steps taken by RBI

A day after the Reserve Bank of India (RBI) announced a raft of measures to improve foreign flows into the country, the rupee rebounded a bit; but it appears the move was similar to several emerging market (EM) currencies and was triggered more by the sharp fall in the prices of commodities, especially crude. The RBI measures by themselves are not expected to improve flows vastly, but may help to scare off speculative attacks — say, by bankers — given the new tools the RBI has shown it will use to defend the rupee. A majority of economists retain their view that the widening current account deficit will continue to have a gradual depreciation impact on the rupee.

The Indian rupee, which has been setting new all-time lows practically every day since June 13, had some respite on Thursday. It opened higher and notched up a half-percent gain before losing the gain as importers bought dollars big time. Dealers noted that the over-10-percent fall in crude prices over the past two days, plus the general fall in many soft commodities and metals, has improved the outlook on commodity-importing countries like India and South Korea.

So what about the steps announced by RBI: one of those key was that banks don’t have to maintain CRR (cash reserve ration) and SLR (statutory liquidity ration) on incremental deposits they get in their FCNR (B) and NRE accounts (these are accounts where in foreigners and NRIs deposit their dollar savings).

Bhaskar Panda of HDFC Bank pointed out that the all-in cost of a one-year FCNR (B) deposit (including hedging) today costs banks close to 6.8 percent. The CRR, SLR exemption brings down the cost to 6.4 percent, but domestic retail deposits can be had for as low as 6-6.2 percent. Hence he argued, private banks  will definitely not chase these foreign deposits. Ashish Vaidya of DBS agreed, but added that if RBI were to raise domestic interest rates to respond to the global tightening, these FCNR (B) and NRE deposits can become attractive for banks and they may actively source foreign deposits. Bankers also said some PSU banks are tight on their dollar resources and they my use this route.

The other key step announced by the RBI is to allow foreign funds to buy bonds of different tenors under the “fully accessible route” . This route was created so as to allow FIIs unlimited access to some Indian bonds and they included the popular 5-, 10- and 30-year bonds. Now the RBI has added the 7- and 14-year bonds to list. Dealers were unsure of the attractiveness of long tenor Indian bonds. But another RBI measure allowing foreign funds to buy shorter term — under 1-year residual maturity — corporate bonds could be successful in attracting traders and funds, money market dealers said.

Net net, no one is betting on a huge inflow of incremental funds and hence, economists continue to worry that  the wide current account deficit may continue to impart a depreciating bias to the rupee.

India’s trade deficit has been widening steadily for the past nine months and came in a $25.5 billion in June led largely by costly imports of crude, coal, and fertilisers. Economists such as from Citi, Kotak, Goldman Sachs and Yes Bank see the current account deficit widening to over 3 percent this year. Capital flows, which traditionally bridge India’s CAD (current account deficit) have been tardy this year, with portfolio funds aggressively pulling out and FDI (foreign direct investment) flows remaining feeble.

Advising clients to remain long on the dollar-rupee, Citi’s Samiran Chakrabarty wrote that the measures announced on Wednesday “likely compliment RBI’s formidable FX (foreign exchange) reserves in managing the pace of INR weakness, but are not potent to push back on the wide balance of payment deficit that shall drive a weaker INR, especially amidst broad USD strength and risk-aversion”.

Goldman Sachs wrote, “We forecast USD/INR at 80, 81, and 81 over 3M, 6M and 12M horizons, with risks tilted towards even further weakness in the event of more acute broad dollar strength.”

Not surprising then, that the rupee erased most of its gains even by end of day on Thursday.