Money matters

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Only a calculated economic and monetary policy can revive the rupee, write Navin Syiem and Anjan Dasgupta at HSA Advocates

The steep fall of the Indian rupee can be attributed to various factors, including the slow progress of economic reforms, which has led to a decline in foreign direct investment (FDI), and an announcement of quantitative easing in the US, which has prompted investors to pull out of India and focus on other economies. Since May alone, the rupee has plummeted approximately 16%.

Propping up the rupee

The Reserve Bank of India (RBI) seems to have adopted a monetary policy designed to suck liquidity out of the country’s financial system in an effort to prop up the rupee. For example, the RBI’s liquidity adjustment facility (LAF) – under which domestic banks can access funds from the RBI – has been reduced in size, limiting access to these borrowed funds. Bank borrowings from the LAF facility will be cut in half and if banks want more funds, they can borrow from the RBI under the marginal standing facility at an interest rate of 10.25%. Such a measure could remove liquidity from the financial system by making commercial loans more expensive.

Navin Syiem
Navin Syiem

Similarly, short-term interest rates have been raised to arrest the fall of the rupee. The interest rate for the marginal standing facility (under which banks can borrow funds from the RBI by pledging approved government securities) was raised to 10.25% from 8.25%, thereby increasing borrowing costs for banks. Other measures adopted by the RBI to reduce liquidity include a bond sale. Bonds worth25.32 billion (US$411 million) were sold by the RBI in the secondary market on 18 July.

The RBI has not been forthcoming about its plans to reverse the steps it has taken to tighten liquidity. Bankers have already expressed concerns, indicating that their profitability may take a hit if these measures continue for more than four to six weeks.

Too little too late?

The big question is whether the RBI’s methods are enough to stop the fall of the rupee and, perhaps, even lead to a currency appreciation. It would be difficult to provide a positive response to this question since the RBI’s moves seem extremely conservative at a time when price inflation is under control and growth is slowing.

The government has added fuel to the fire, delaying announcements of big-ticket reforms that will attract foreign investors and drive foreign exchange inflows into India. The recent relaxation of India’s FDI policy to attract capital inflows in sectors such as insurance, telecoms, multi-brand retail trading and aviation is expected to draw in foreign capital, which in turn could revive the economy and strengthen the rupee. However, whether this will actually happen remains to be seen.

Anjan Dasgupta
Anjan Dasgupta

For instance, raising the FDI cap in the insurance sector from 26% to 49% will have little effect if parliament does not clear the Insurance Bill. The government has permitted 100% FDI in the telecom sector, however, given the chaos following the 2G spectrum scam (particularly with Telenor and Sistema burning their fingers), tough competition and tight regulations, foreign companies may think twice about investing. Similarly, allowing FDI in multi-brand retail has failed to attract any appealing proposals. Walmart is contemplating exiting India after recent scandals relating to bribery, while IKEA is yet to announce any concrete plans for the country.

Revival requires more

The RBI’s monetary policy coupled with the inability of the government to push concrete economic reforms through in a well planned manner has led to India falling out of favour with foreign investors. Additionally, the lack of clarity over government policy, infrastructure constraints, unclear tax policies and a general unwillingness to be business friendly has led to foreign money fleeing India for more attractive investment destinations.

Several proposals have been designed to ease the rules around the inflow of foreign exchange into India. These include relaxing the external commercial borrowing (ECB) policy; permitting Indian subsidiaries of multinational companies to borrow funds from their parent companies for working capital purposes (which was not a permitted end use of ECB proceeds); and permitting the repayment of rupee loans from ECB proceeds. However, the need of the hour is for the RBI and the government to work together and craft a well formulated economic and monetary policy that will contain price inflation, fuel domestic demand, revive economic growth and attract significant foreign investment. A tall order, no doubt, in the run-up to the 2014 elections.

Navin Syiem and Anjan Dasgupta are partners at HSA Advocates and can be contacted at [email protected] and [email protected] The authors thank Shraddha Malhotra (an associate at HSA Advocates) for her contributions to this article.