RBI’s Pain To Achieve Rupee’s Gain

The RBI has been knocking every possible door in order to pull back the falling rupee. Its efforts have, however, not yielded the desired results so far. The market now looks forward to the First Quarter Monetary Policy Review of the RBI, says Shrikant Akolkar

There is an old saying ‘Troubles never come singly’. It seems that the Indian economy is liv- ing this phrase at the moment. There is a long list of problems that the Indian economy is currently facing - economic slowdown, foreign investors fleeing away, twin deficits etc. In such a scenario, depreciation of the currency is the new demon for the economy. The consistent depreciation of the currency has troubled the RBI to no end.

The economy is in deep trouble with the rupee’s slide as it has now increased the chances of sovereign downgrade and further widening of the current account deficit (CAD). To reinstate the lost sheen of the currency, the government has hiked the FDI limits in various sectors in order to attract foreign funds while the RBI has tightened the excess liquidity in the economy. The market is, however, worried about the forthcoming First Quarter Monetary Policy Review due on July 30, 2013.

Immediately after the meeting of the Federal Open Market Committee’s (FOMC) announcement regarding the tapering of quantitative easing earlier than expected, there has been a huge sell-off of securities in the global capital markets. Due to the integration of the global financial markets, the domestic markets have also become a part of this global system. Since the FOMC meeting, FIIs sold financial securities (debt and equity) worth INR 39630 crore. This huge outgo has seen the rupee tanking to a historic low of INR 61 against the US dollar. Although it has shown a marginal recovery, the RBI has tightened the liquidity in the country owing to the many woes that the rupee’s fall brought forth.

The RBI, on July 15, took a drastic step to increase the short-term lending rates, due to the improving domestic liquidity that lead to an increase in demand of foreign currency. The RBI increased the bank rate and Marginal Standing Facility (MSF) rate by 200 basis points to 10.25 per cent each. This is 300 basis points above the policy repo rate. At a time when the economy is grappling with the slow- down and poor demand, the move was not welcomed by the market. The RBI and the Prime Minister were quick to say that these were only short-term steps and that the long-term rates will not be impacted. The apex bank also announced an open market sale of Government of India Securities worth INR 12000 crore on July 18, 2013. This, however, did not take place as expected. Following these measures, the rupee remained near its historic low.[PAGE BREAK]

Seeing that the rupee is not showing any positive impact, the RBI on July 23, 2013 intervened by limiting the liquidity adjustment facility (LAF) to 0.5 per cent of the total deposits from the earlier one per cent. It also asked banks to maintain the average daily Cash Reserve Ratio (CRR) at 99 per cent of the requirement against the earlier 70 per cent. Under this, banks are required to keep a portion of their deposits with the RBI. This measure is expected to suck INR 5000 crore from the banking system. The new measures would come in effect from July 27, 2013, just a couple of days before the RBI’s First Quarter Monetary Policy Review.

The measures have so far been ineffective as the rupee, since the RBI’s intervention, has only recovered by a per cent.

The RBI has also taken steps to curb speculative currency trading and has asked oil companies to buy dollars from a single window. It is also believed that the RBI, earlier this month, may have sold some dollars to halt the rupee’s slide. The apex bank has forex reserves of USD 287 billion and hence its ability to sell dollars remains limited. While everything has failed so far, eyes are set on the RBI’s monetary policy review. The market is concerned about a hike in the repo rate or CRR.

Prasanna Patankar, Senior Bond Dealer at STCI Finance believes that the liquidity tightening by the RBI is equivalent to a 50 basis point pseudo CRR hike. He expects further liquidity tightening in the next few months. According to a head of the treasury of a state-owned bank, there won’t be any rate cut ahead in this year. The only possibility of a rate cut is in the fourth quarter of the fiscal.

With the RBI’s frequent intervention, there is an undeniable possibility of a hike in policy rates. The hike in short-term rates has already indicated that the RBI is stern in meeting its objectives. We have seen how it had already hiked policy rates to tame inflation. Rupee is now its main focus and the possibility of a hike in the policy rate to suck liquidity in the system remains very much alive. Nevertheless, the term of the RBI Governor D Subbarao, who is set to retire in September this year, will always be remembered by the markets for years to come.