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Rupee Depreciation: Probable Causes and Outlook: Primarvdcalcrl - LD
Rupee Depreciation: Probable Causes and Outlook: Primarvdcalcrl - LD
Ld
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+91-22-66202234
The Indian Rupee has depreciated significantly against the US Dollar marking a new risk for Indian economy. Till the beginning
of the financial year (Apr 11-Mar 12) very few had expected Rupee to depreciate with most hinting towards either appreciation or
status quo in the rupee levels. Those few who had even anticipated may not have imagined the scale of depreciation with rupee
touching a new low of around Rs 54 to the US Dollar.
What is even more interesting to note is that when other countries are trying to play currency wars and trying to keep their
currencies devalued, India is trying to prevent depreciation of the currency. cad our previous report for a review of the situationSaying No To Currency Wars (20-Sep-I 1))
This paper reviews the probable reasons for this depreciation of the rupee and the outlook for the same. It also reflects on the
policy options to help prevent the depreciation of the Rupee
I. Economics of Currency
Predicting currency movements is perhaps one of the hardest exercises in economics as it has many variables affecting the market
movement.:
Balance of Payments: It is the sum of current account and capital account of a country and is an external account of a country
with other countries. Both current account and capital account play a role in determining the movement of the currency:
o Current Account Surplus/Deficit Current account surplus means exports are more than imports. In economics we assume prices
to be in equilibrium and hence to balance the surplus, the currency should appreciate. likewise for current account deficit
countries, the currency should depreciate.
o Capital Account flows: As currency adjustments do not happen immediately to adjust current account surpluses and deficits,
capital flows play a role. Deficit countries need capital flows and surplus countries generate capital outflows. On a global level
we assume that deficits will be cancelled by surpluses generated in other countries. In theory we assume current account deficits
will be egual to capital inflows but in real world we could easily have a situation of excessive flows. So, some countries can have
current account deficits and also a balance of payments surplus as capital inflows are higher than current account deficits. In this
case, the currency does not depreciate but actually appreciates as in the case of India (explained below). Only when capital
inflows are not enough, there will be depreciating pressure on the currency.
Interest Rate Differentials: This is based on interest rate parity theory. This says that countries which have higher interest rates
their currencies should depreciate. If this does not happen, there will be cases for arbitrage for foreign investors till the arbitrage
opportunity disappears from the market. The reality is far more complex as higher interest rates could actually bring in higher
capital inflows putting further appreciating pressure on the currency. In such a scenario, foreign investors earn both higher
interest rates and also gain on the appreciating currency. This could
21 Dcc2OlI PrimarvDcalcrl.Ld
lead to a herd mentality by foreign investors posing macroeconomic problems for the monetary authority.
Inflation: Higher inflation leads to central banks increasing policy rates which invites foreign capital on account of interest rate
arbitrages. This could lead to further appreciation of the currency. However, it is important to differentiate between high inflation
over a short term versus a prolonged one. Over short-term foreign investors see inflation as a temporary problem and still invest
in the domestic economy. If inflation becomes a prolonged one, it leads to overall worsening of economic prospects and capital
outflows and eventual depreciation of the currency.
Apart from this, inflation also helps understand the real changes in a value of currency. Real exchange rate = Nominal Exchange
Rate* (Inflation of foreign country/Inflation of domestic economy). This implies if domestic inflation is higher, the real change in
the value of the currency will be lower compared to the nominal change in currency.
Fiscal Deficit: Fiscal deficits play a role especially during currency crisis. If a country follows a fixed exchange rates and also
runs a large fiscal deficit it could lead to speculative attacks on the currency. Higher deficits imply government might resort to
using forex reserves to finance its deficit. This leads to lowering of the reserves and in case there is a speculation on the currency,
the government may not have adequate reserves to protect the fixed value of the currency. This pushes the government to devalue
the currency. So, though fiscal deficits do not have a direct bearing on foreign exchange markets, they play a role in case there is
a crisis.
Global economic conditions: Barring domestic conditions, global conditions impact the currency movement as well. In times of
high uncertainty as seen lately, most currencies usually depreciate against US Dollar as it is seen as a safe haven currency.
Hence even over a longer term, multiple factors determine an exchange rate with each one playing an important role over time.
II. Rupee Movement since 1991
If we look at Indias Balance of Payments since 1970-71, we see that external account mostly balances in I 970s. Infact in second
half of I 970s there is a current account surplus. This was a period of import substitution strategy and India followed a closed
economy model. In I 980s, current account deficits start to rise culminating into a BoP crisis in 1991. It was in the 1991 Union
Budget where Indian Rupee was devalued and the government also opened up the economy. This was followed by several
reforms liberalizing the economy and exchange rate regime shifted from fixed to managed floating one. Hence, we need to
analyse the current account and rupee movement from 1991 onwards.
India has always had current account deficit barring initial years in 2000s (Figure 1). The deficit has been financed by capital
flows and mostly capital flows have been higher than current account deficit resulting in balance of payments surplus. The
surplus has intum led to rise in forex reserves from USD 5.8 bn in 1990-91 to USD 304.8 bn by 2010-11 (Figure 2). In 1990-91,
gold contributed around 60% of forex reserves and forex currency assets were around 38%. This percentage has changed to
1.5% and 90% respectively by 2010-11.
2
.A ,- - . ,. e -
Based on this, if we look at Rupee movement, we broadly see it has depreciated since 1991. Figure 3 looks at the Rupee
movement against the major currencies. A better way to understand the Rupee movement is to track the real effective exchange
rate. Real effective exchange rate (REER) is based on basket of currencies against which a country trades and is adjusted for
inflation. A rise in index means appreciation of the currency against the basket and a decline indicates depreciation. RBI releases
RIER for 6 currency and 36 currency trade baskets since 1993-94 and we see that the currency did depreciate in the I 990s but
has appreciated post 2005. It depreciated following Lehman crisis but has again appreciated in 2010-11.
Forcx Reserve (in $ bn)
350
300
250
ISO
. 1
IIIII
II
II
II
a
3
Current
Account
Capital
Account
1990-00
-3.8
7.9
4.1 23.5
2000-11
-11.6
33.6
22.0 174.8
2000-05
3.7
14.7
18.4 85.4
2005-11
-24.3
49.3
25.0 249.4
Sswnv: RItZ
21 Dcc 2011
Figure 3
S.n: RB!
Figure 4
Table 2 summarizes the findings of Balance of Payments and Rupee movement. In the I 990s, Rupee depreciates against its major
trading currencies as the average REER is less than 100. However, in 2000s we see Rupee appreciating against major trading
currencies. If we divide the 2000s period further to 2000-05 and 2005-Il, we see there is depreciation in the first phase and large
appreciation in the second half of the decade.
Table 2: Balance of Payments and Rupee
Hence, overall we see the Rupee following the path economic theories highlighted above have suggested.
As India opened up its economy post 1991, Rupee depreciated as it had current account deficits. Earlier current account deficits
were mainly on account of merchandise trade deficits. However, as services exports picked up it helped lower the pressure on
current account deficit majorly. Without services exports, current account deficit would have been much higher.
There was a blip during South East Asian crisis when current account deficit increased from $4.6 bn to $5.5 bn in 1997-98.
Capital inflows declined from $11.4 bn to $10.1 bn leading to a decline in BoP surplus and depreciation of the rupee. However,
given the scale of the crisis the depreciation pressure on Rupee was much lesser. There was active monetary management by RBI
during the period. Similar measures have been taken by RBI in current phase of Rupee depreciation as well (discussed below).
Till around 2005, India received capital inflows just enough to balance the current account deficit. The situation changed after
2005 as India started receiving capital inflows much higher than current account deficit. The capital inflow composition also
changed where external financing dominated in early I 990s and now most of the capital inflows came via foreign investment.
Within foreign investment, share of portfolio flows was much higher. As capital inflows were higher than the current account
deficit Rupee appreciated against major currencies.
Rupee major curenciuu
70
60
50
40
30
30
10 -
BoP
(in $ bn)
6 REER 36 REER
1990-00
4.1
99.5 98.5
2000-11
22.0
103.4 100.6
2000-05
18.4
99.2 99.8
2005-10
25.0
107.0 101.2
Sown: RB!
Other factors also led to appreciation of the rupee. First, India entered a favorable growth phase registering growth rates of 9%
and above since 2003. This surprised investors as few had imagined India could grow at that rate consistently. The high growth
led to surge in capital inflows mainly in portfolio inflows. Second, Indias inflation started rising around 2007 leading to RBI
tightening policy rates. This led to higher interest rate differential between India and other countries leading to additional capital
inflows as highlighted above. It is important to understand that at that time investors did not feel inflation will remain persistent
and thought it to be a transitory issue and could be tackled by monetary policy.
During Lehman crisis capital flows shrunk sharply from a high of $107 bn in 2007-08 to just $7.8 bn in 2008-09 and led to
sharp depreciation of the currency. Rupee plunged from around Rs 39 per $ to Rs. 50 per S. REER moved from 112.76 in 200708 to 102.97 in 2008- 09 depreciating sharply by 9.3%. The current account deficit also declined sharply as well tracking decline
in oil prices from S 12 bn in Jul-Sep 08 to $0.3 bn in Jan-Mar 09. The currency also depreciated tracking the global crisis which
led to preference for dollar assets compared to other currency assets.
Indian economy recovered much quicker and sharper from the global crisis. The capital
inflows increased from $7.8 bn to $51.8 bn in 2009-10 and $57 bn in 2010-11. The higher
capital inflows were on account of both FDI and RI. External Commercial Borrowings also
picked up in 2010-11. The current account deficit also increased from $27.9 bn in 2008-09 to
$44.2 bn in 2010-11. REER (6 currency) appreciated by 13% in 2010-Il and 36 REER by
7.7%.
III. Depreciation of Rupee: 2011-12
Before we analyse the factors for the recent depreciation of the rupee, let us look at the survey of professional forecasters released
by RBI. Current account deficit is more or less same buy consensus expects capital inflows in 2010-11 to be lower in each
succeeding quarter. This leads to lower BoP estimate. However, the forecasters maintain their forecast for Rupee/Dollar
unchanged. This is surprising as with lower capital inflows, markets should have expected some depreciating pressure on Rupee
as well. BoP surplus of $10.3 bn would have been lowest (barring 2008-09) figure since 2000- 01. The lowest figure for
INR/USD is 47.1 in Q3 10-11,46 in Q4 10-11 and 45.6 in QI 10-11. It is
Composition of Capital Inflows
100/
90,.
II
70/. ____________
4fo
0,.
Dm1 HI C F.xtanal astistan C ICB NRI Dcposit
2000-Il
21 Dcc 2011
safe to say most of the participants missed the estimate by a wide mark. It was a complete surprise for most analysts.
Even the QI 11-12 numbers did not really sound an alarm (Table 4). The current account deficit was
at S14.2 bn and capital account was at $19.6 bn leading to a BoP surplus of $5.4 bn. BoP surplus in
Q4 2010-11 was S 2bn. More importantly, capital inflows had risen from $7.4 bn in Q4 2010-11 to S
19.6 bn in QI 2011-12 on account of foreign investment (both FDI and Fil).
The problems start to surface from Q2 11-12 onwards. In Table 4, we have put some of the data released by RBI and
Commerce Ministry for the period post QI 11-12. As we can see, current account deficits is likely to be higher but capital
inflows especially Fli inflows are going to be much lower. Compared to EAC projections, current account deficit is likely
to be higher and capital account lower leading to either a negligible BoP surplus or BoP deficit.
Table 4: Balance of Payments in 2011-12 (Actuals vs. EAC projections, in $ bn)
Apart from difficulty in capital inflows, Indian economy prospects have declined sharply. Just at the beginning of the year,
forecasts for Indias growth for 2011-12 were around 8-8.5% and have been revised downwards to around 6.5%-7%. It has
been a shocking turnaround of events for Indian economy. Both foreign and domestic investors have become jittery in the last
few months because of following reasons:
6
etiod
Q3201011
Q4201011
Ql201112
Rupee/USD
43.5
44.5
44.5
-59.4
-56.9
-54.7
83
75
65
23.6
18.1
10.3
Som,w: P.111
QI 1112
Jul 11Oct 11
PMsEAC
Projection
Trade Deficit
-35.5
-54.5
-154.0
Exports of Goods
80.6
98.3
330.2
Imports of Goods
116.1
Net Invisibles
21.3
Services exports
31.0
45.0
Services Imports
18.9
26.4
12.1
18.6
Transfers + Income
9.3
39.5
-14.2
-54.0
Q1
152.9
484.2
100.0
Jul-Il
to Aug11
Capital Account
19.6
FDI
7.2
13.8
HI
2.5
0.6
ECB Borrongs
2.9
NRI Deposits
1.2
60.5
Sep-il to
20-Dec 1
72.0
32.0
1.5
14.0
0.9
Others 5.8
Sm: Kill
uncertainty over domestic economy has also made investors nervous over Indian economy which has further fuelled depreciation pressures. India
was receiving capital inflows even amidst continued global uncertainty in 2009-11 as its domestic outlook was
55
Depreciation of Rupee against US Dollar
53 51
49
47
45
43
-5
21 Dcc2OlI PrimarvDcalcrl.Ld
positive. With domestic outlook also turning negative, Rupee depreciation was a natural outcome. Depreciation leads to imports becoming
costlier which is a worry for India as it meets most of its oil demand via imports. Apart from oil, prices of other imported commodities like
metals, gold etc will also rise pushing overall inflation higher. Even if prices of global oil and commodities decline, the Indian consumers might
not benefit as depreciation will negate the impact. Inflation was expected to decline from Dec-I I onwards but Rupee depreciation has played a
spoilsport. Inflation may still decline (as there is huge base effect) but Rupee depreciation is likely to lower the scale of decline.
What are the policy options with RBI?
Raising Policy rates: This measure was used by countries like Iceland and Denmark in the initial phase of the crisis. The rationale was to prevent
sudden capital outflows and prevent meltdown of their currencies. In Indias case, this cannot be done as RBI has already tightened policy rates
significantly since Mar-10 to tame inflationary expectations. Higher interest rates alongwith domestic and global factors have pushed growth
levels much lower than expectations. In its Dec-Il monetary policy review, RB! mentioned that future monetary policy actions are likely to
reverse the cyde responding to the risks to growth. Indias interest rates are already higher than most countries anyways but this has not led to
higher capital inflows. Oin the other hand, lower policy rates in future could lead to further capital outflows.
Using Forex Reserves: RBI can sell forex reserves and buy Indian Rupees leading to demand for rupee. RBI Deputy Governor Dr. Subir Gokarn
in a recent speech (An assessment of recent macroeconomic developments, Dec-I 1) said using forex reserves poses problems on both sides
Not using reserves to prevent currency depreciation poses the risk that the exchange rate will spiral out of control, reinforced by self-fulfilling
expectations. On the other hand, using them up in large quantities to prevent depreciation may result in a deterioration of confidence in the
economys ability to meet even its short-term external obligations. Since lx)th outcomes are undesirable, the appropriate policy response is to find
a balance that avoids either.
Based on weekly forex reserves data (Figure 8), RBI seems to be selling forex reserves selectively to support Rupee. Its intervention has been
limited as liquidity in money markets has remained tight in recent months and further intervention only tightens liquidity further.
Figure 8
Forcx Rccrvcs (in S bn)
325.0
310.0
N
305.0
300.0
295.0
N.
Sn7: Kill
Easing Capital Controls: Dr Gokarn in the same speech said capital controls could be eased to allow more capital inflows. He added that
resisting currency depreciation is best done by increasing the supply of foreign currency by expanding market participation. This in essence,
8
21 Dcc2OlI PrimalvDcalcrl.Ld
has been RBIs response to depreciating Rupee. Following measures have been taken lately:
o Increased the FlI limit on investment in government and corporate debt instruments.
o First, it raised the ceilings on interest rates payable on non-resident deposits. This was later deregulated allowing banks to
determine their own deposit rates.
o The all-in-cost ceiling for External Commercial Borrowings was enhanced to allow more ECB borrowings.
Administrative measures: Apart from easing capital controls, administrative measures have been taken to curb market
speculation.
o Earlier, entities that borrow abroad were liberally allowed to retain those funds overseas. They are now required to bring the
proportion of those funds to be used for domestic expenditure into the country immediately.
o Earlier people could rebook forward contracts after cancellation. This facility has been withdrawn which will ensure only
hedgers book forward contracts and volatility is curbed.
o Net Overnight Open Position Limit (NOOPL) of forex dealers has been reduced across the board and revised limits in respect
of individual banks are being advised to the forex dealers separately.
After these recent measures, Rupee depreciation has abated but it still remains under pressure. Both domestic and global
conditions are indicating that the downward pressure on Rupee to remain in future. RBI is likely to continue its policy mix of
controlled intervention in forex markets and administrative measures to curb volatility in Rupee. Apart from RBI, government
should take some measures to bring FDI and create a healthy environment for economic growth. Some analysts have even
suggested that Government should float overseas bonds to raise capital inflows.
V. Conclusion
Growing Indian economy has led to widening of current account deficit as imports of both oil and non-oil have risen. Despite
dramatic rise in software exports, current account deficits have remained elevated. Apart from rising CAD, financing CAD has
also been seen as a concern as most of these capital inflows are short-term in nature. PMs Economic Advisory Council in
particular has always mentioned this as a policy concern. Boosting exports and looking for more stable longer term foreign
inflows have been suggested as ways to alleviate concerns on current account deficit. The exports have risen but so have prices of
crude oil leading to further widening of current account deficit. Efforts have been made to invite FDI but much more needs to be
done especially after the holdback of retail FDI and recent criticisms of policy paralysis. Without a more stable source of capital
inflows, Rupee is expected to remain highly volatile shifting gears from an appreciating currency outlook to depreciating reality
in quick time.
9
CARE recently released a report on the outlook for Indian Rupee with regard to other
currencies. The report is reproduced below :
Looking forward, it may be gauged that market participants expect little reversal in
this trend of rupee depreciation. Forward premium on the dollar is the cost of
carry of the dollar for specified tenure which may also be interpreted as the
expected movement in the exchange rate. Using the inter-bank forward premium
for different tenure as an indicative measure of the rupee rate, we may infer that
rupee depreciation may persist for a while.
The one month forward premium on the dollar has especially registered a
substantial jump of 454 bps between August and November (Table 1).
Causes of Depreciation
1. Withdrawal by FIIs
The main driver of rupee depreciation in the last three months has been the
withdrawal of funds by foreign institutional investors (FIIs) from domestic economy.
The rather pessimistic view of FIIs is being governed by global developments. FIIs have
registered a net sales position of US $ 1,581 million, between August and November so
far.
could cause further depreciation in rupee. While FDI has been increasing it has not
been able to make up for lower other capital inflows.
Impact of Rupee Depreciation
Three areas of concern that may be identified are higher import bills, fiscal slippage and
increased burden on borrowers
1. Higher Import Bills
A depreciation of the local currency naturally manifests in higher import costs for
the domestic economy. Assuming that both imports and exports maintain their current
growth rates through the year, higher import costs would widen the trade and current
account deficit of the country. We expect current account deficit to settle at 3.03.1% of GDP by March 2012- end. Additionally, the domestic economy could be faced
with a problem of higher inflation through imports. Commodities prices that are
internationally denominated in US dollars would naturally be priced higher on the back
of a stronger Dollar. Also, while global base metals prices such as nickel, lead,
aluminium, iron and steel would have eased, the depreciating rupee would keep
the price of imported commodities elevated.
2. Fiscal Slippage
The fiscal deficit for FY12 was budgeted at 4.6% of GDP in February, with the
price of oil pegged at US $ 100 per barrel. Throughout FY12 so far, however, the price
of oil has been well above this reference rate, hovering at an average of US $ 110 over
the last three months. Oil subsidy for the year is about Rs 24,000 crore for FY12. This
will rise on account of the higher cost of oil being borne by the government. While
there have been moves to link some prices of oil-products to the market, there would
still tend to be an increase in subsidy on LPG, diesel, kerosene. The
government has already enhanced its borrowing programme in H2 FY12 by Rs
52,000 crore, to bridge the fiscal gap.
3.Increased burden on Borrowers
Higher rates will come in the way of potential borrowers in the ECB market. Today given
the interest rate differentials in domestic and global markets, there is an advantage in
using the ECB route. With the depreciating rupee, this will make it less attractive.
Further, those who have to service their loans will have to bear the higher cost of debt
service.
4.Impact on exports
Usually exports get a boost in case the domestic currency depreciates because exports
become cheaper in international markets. However, given sluggish global
conditions, only some sectors would tend to gain where our competitiveness will
increase such as textiles, leather goods, processed food products and gems and
jewellery. In case, imported raw material is used in these industries they would be
adversely affected. Therefore, exports may not be able to leverage fully.
The rupee during these two months has seen the sharpest depreciation (of 96 paise)
on a daily basis (based on RBI reference rate) on June 19, 2013, following early
indications of the FOMC tapering QE3.
o
The absence of easy money and ample liquidity as provided by the Fed with its
unlimited bond-buying programme and accommodative monetary policy stance
sparked sudden fear in the minds of investors. Multiple rounds of the QE
programme had been supporting both advanced and emerging market
economies and an earlier-than-expected tapering of the same came as a shock
to global investors. While the Fed has now clarified that it will continue with the
QE programme, tapering cannot entirely be ruled out and investors appear to be
factoring in this uncertainty more explicitly now.
The highest appreciation of the rupee during this period (of 98 paise), on the other
hand, came a day after the RBI announced easing of rules for non-bank asset
finance companies to raise to overseas debt.
During this period of two months, there has been no clear-cut reversal in the
direction of change in rupee rate against the dollar (the exception being 25th July
where the rupee went into the Rs 58.90-59 range). Measures such as gold import
duty rise, restrictions on lending against and tightening of liquidity have caused the
rupee to inch up only marginally on a day-to-day basis.
Starting the first prominent series of announcements on June 6, 2013, when the RBI
reference rate for rupee settled at Rs 56.87 to a dollar, till the most recent measure
announced on July 24, 2013 when the exchange rate settled at Rs 59.44 to a dollar,
the rupee has depreciated 4.5%.
Capturing Sentiment
An obvious conclusion to draw here would be that these measures have had limited
impact on the rupee. But, to the extent these measures have worked they have
ensured that the pace of depreciation has been checked and the rupee has ranged
between Rs 59-60/$. However, the impact on sentiment has been more
discernible. Reactions of FIIs and banking stocks to rupee-related news have been
captured in the following two exhibits.
Exhibit 1 charts daily net FII inflows a day after announcements by RBI (most news
have been released after market hours and reactions of FIIs would be reflected on the
following day) and Exhibit 2 charts daily changes in BSE S&P Bankex (over the
previous day) on account of news
Net FII inflows have mostly been in the negative territory during the last two
months. FIIs withdrew substantially on days after the RBI announced extension in
buyback time period of FCCBs, tightened gold lending norms for RRBs and
restricted daily liquidity by capping available funds under the Liquidity adjustment
facility (LAF) to Rs 75,000 crore and raising short-term rates.
o
Contrary to this trend, net FII inflows were positive a day after the July 23, 2013
announcement that allowed for further tightening of liquidity in the banking
system. It may be conjectured that investor expectations of earning arbitrage
profit on the back of tighter monetary policy and higher interest rates in local
markets could have prompted this move. It remains to be seen if such inflows
would be sustained in the coming months.
The BSE bankex dipped as investors presumably exited banking stocks postannouncements of RBI allowing deferment of payment of forex option premium,
easing norms for low-cost builders to raise ECBs and non-bank asset finance
companies to raise overseas debt. The bankex unexpectedly picked up, moving
to the positive zone once SEBI announced stricter exposure norms for currency
derivatives and stayed there seemingly on the back of some banks announcing
better-than-expected Q1 FY14
With the July 23 announcement that further curtailed individual bank access to
LAF and increased CRR requirements, the bankex dipped substantially as the
move would directly impact banks business activity, which has already been
subdued over the past two years
Impact on Liquidity
Along with directly targeting the rupee rate, the RBI in its July 15, 2013 announcement
also looked at steps to squeeze out liquidity. The following three steps had been
outlined
1. The MSF rate was recalibrated upwards by 300 bps to 10.25%, also implying that
the bank rate automatically moved up to 10.25%
2. The overall allocation of funds available under LAF was limited to 1% of NDTL of the
Indian banking system i.e. to Rs 75,000 crore, each day (with effect from July 17,
2013), and
On July 23, 2013, the RBI made another set of announcements targeting liquidity in the
banking system
1. The overall limit for access to LAF by each individual bank is now set at 0.5% of the
banks own NDTL outstanding (as on the last Friday of the second preceding fortnight);
effective from July 24, 2013
2. The minimum daily CRR balance to be maintained by banks has now been elevated
to 99% on a daily basis (from the previous 70%); effective from the reporting fortnight
beginning July 27, 2013
3. Auction of cash management bills to the tune of Rs 6,000 crore
The path of sustained monetary easing appears less likely now, given that the RBI
has now turned hawkish in its stance to cap depreciation of rupee and limit the
widening of CAD. Inflation, particularly imported inflation is expected to move
upwards, but only at the margin.
The rupee is expected to face pressure during the year and movement in
exchange rate would be range-bound; the Rs 59-60 to a dollar being the new
normal for the rupee rate.
CARE expects a rate cut of 50 bps in H2 FY13, in two tranches (more likely
towards November- December), highly contingent on dynamics of rupee
depreciation, CAD and inflation. An adverse data input on any of these macrovariables would be viewed strictly by the RBI and a rate hike scenario cannot
entirely be ruled out.
While these measures may be viewed as temporary, the hike in short-term interest
rates would defer banks decisions to cut lending rates in the immediate run.
o Credit disbursement may hence, be expected to continue in is subdued phase
for a while and would likely settle lower than expected in FY14 again.
Yields across maturities are expected to firm up and CP and CD funding rates would
be no exception. This could accentuate the problem of a low investment cycle at the
macro-level as firms once again move to sidelines in CP issuances, largely used to
finance working capital.
o The 10-year GSec could will be under pressure until further guidance is received
from the RBI and the rupee stabilizes. The range of 8.3-8.5% looks more likely in
the very short run and the Policy statement later this month will provide further
direction. While these measures appear to be temporary, with a motive to
stabilise the rupee; the RBI would be reviewing them from time to time. Hence,
the direction and magnitude of change in interest rates becomes crucial.
Attaining normalcy in terms of exchange rate and RBI policy reversals would
take the yield back to the 7.5- 7.6% range, though the timing is uncertain.
o
Short-term rates for CP and CD in such a scenario could very well range in
double digits for some more time. Any reversal in current moves by the RBI is
almost immediately expected reverse the impact on both long-term GSec yields
and short-term interest rates.
Until such time that domestic interest rates remain high, Indian corporates could be
prompted to access the ECB/FCCB market to a greater extent depending on the
interest rate differentials and currency risk.
o
Annexure 1