Dariusz Kowalczyk, senior economist, Asia ex-Japan, Credit Agricole CIB:
Indian policy makers are continuing their efforts to stem the depreciation of the rupee – the worst performing currency in emerging Asia this year. They have recently announced a flurry of measures directly or indirectly impacting the FX market. They include an increase in the limit for foreign investment in government bonds, the Prime Minister Singh’s pledge to revive investment, and recommendation by the Central Board of Direct Taxes not to use the recently past tax laws related to foreign investors retroactively.
We believe that the latter measure, if implemented, would be particularly important, as it could restore some of the investor confidence lost as a result of the earlier plan to use tax changes retroactively. While full recovery of foreign investor sentiment would take time, this would be a major first step.
However, for a lasting recovery of the rupee, we would need to see a turnaround in India’s fundamentals – in particular lower inflation and monetary easing, more balanced fiscal position, narrower current account gap, and faster growth. As long as the three former continue to exhibit large imbalances, the currency will remain highly vulnerable. We do expect fundamental improvement in the second half, which should allow the rupee to rise past 53 against the dollar by the year end.
Sanjay Mathur, head of research and strategy, Asia-Pacific ex-Japan, RBS:
The best or worst (depending on how you look at it) of rupee depreciation is now behind us. This view is not predicated on the recent capital account liberalisation measures, but rather that the country's external imbalances will recede alongside the exceptionally weak growth momentum. Declining oil prices are another factor.
This latest bout of rupee weakness principally reflected two policy missteps which impacted investor sentiment: firstly, to retroactively tax capital gains from the sale of companies outside India when the underlying assets were in India and, secondly, attempts to curb the use of tax shelters like Mauritius.
The policy response to the rupee weakness also underwhelmed. The problem was these measures only removed some of the existing rigidities on inward capital mobility but failed to improve the sentiment on the Indian economy and assets. Followers of the Indian economy will recall that foreign capital inflows have in the past been considerably larger when the capital account was less liberalised.
So where lies the case for stabilisation of the rupee? Two developments are likely, in our view: the trade and current account deficit are likely to recede alongside the slowing economy and declining oil prices will provide further support. Appreciation of the rupee would, however, depend on the revival of the reforms process.
Sameer Goel, head of Asia FX and rates research, and Mallika Sachdeva, Asia FX strategist, Deutsche Bank:
While the current account deterioration is likely to be arrested by the drop in oil and gold prices, attracting capital flows is now central to reviving the rupee. In this respect expanding foreign institutional investor limits in debt-securities did not miss the point. However, the measures were in themselves too limited in scale and scope. What is needed for a sustainable turnaround in the rupee is evidence of progress on macro-policy reforms.
While the rupee may enjoy temporary relief on a spurt in bond inflows, a deeper recovery will require either a much larger debt offering or reforms that address India’s crippling twin deficits. To put into perspective, $5 billion of inflows would meet less than half of India’s monthly oil-related US dollar demand. A more expedient short-term fix would thus have been to divert part or all of this dollar demand to the central bank’s balance sheet.
Any bond inflows on the back of this move will be seen as a one-off, and such piecemeal increase in FII quotas is unlikely to be sustainable. The immediate appetite for Indian debt too is questionable, given its worsening credit outlook, and RBI's decision to stay on hold. The rupee would be far better served by attracting stickier and more economically beneficial foreign inflows. Allowing FDI in multi-brand retail would be a key signpost of progress in that respect. Similarly, reducing fuel subsidies will not only help reduce demand for oil imports, but also improve the government’s fiscal accounts, and boost investor sentiment by signaling that tough policy decisions are being made.
Olivier Desbarres, head of FX strategy, Asia-Pacific, Barclays:
The measures which the government and central bank announced recently are a step in the right direction, in our view, to the extent that they will likely provide some support to capital inflows over the medium-term. But they do nothing to address the underlying current account deficit and ultimately the economy’s capacity constraints. Furthermore, the restrictions imposed on the maturity of bonds investors can purchase will likely curtail foreigners’ purchases of local currency government bonds. These measures are thus likely necessary but insufficient to stop the rupee from weakening when weak global risk appetite or negative domestic news stymies portfolio and capital inflows into India.
Policy-makers have further policy options open to them, including relaxing the rules related to withholding taxes, issuing bonds for near-term residents and creating a US dollar-lending facility for oil companies. But again, these measures may not have a lasting impact on the market’s perception of the rupee. Similarly, while the positive impact of falling energy/oil on India’s twin deficits and recent rebound in global risk sentiment post the EU Summit will provide some rupee relief, markets will likely look to the government for a more comprehensive solution to persistent rupee pressure.
Rohini Malkani, economist, Citi:
The rupee’s weakness — despite the sharp correction in crude oil prices — has caught many by surprise. It is driven by both domestic and external factors.
Domestic Factors: The issue of the deficits resulting in India's top-down macro story de-rating over the last year, with growth expectations now in the 5.5-6.5% range compared to 7.5-8% levels just a year ago. A rising current account deficit and lacklustre foreign flows have resulted in FX reserves remaining largely stagnant over the last three years. This is reflected in FX import cover coming off significantly from 14 months of import cover in the 2008 financial year to 5.7 months in 2012. While the Reserve Bank of India and the Ministry of Finance have been taking various measures to enhance dollar inflows, these have been perceived as being reactive rather than proactive, thus resulting in the currency remaining weak.
External Factors: The rupee has also been impacted by deteriorating global risk sentiment and concerns of a global economic slowdown.
Outlook: Our global macro team expects the rupee to retrace back to the 54-55.5 range against the dollar in the next 12 months. On the one hand, the rupee appears oversold, and policy makers are expected to intervene strongly as it weakens further. Declines in oil prices should also help India's current account position. Going forward, we could also see the possibility of commercial dollar bond issue dollar swap-lines, and gold imports coming under further scrutiny - all of which could have a more meaningful impact on dollar inflows.
Vivek Rajpal, FX strategist, Nomura:
The steps taken by RBI were rather tactical in nature and can be seen as modest liberalization of capital flows. As such the RBI eased controls by a) widening the investor base for FII that can access the onshore government bond market; b) raise the FII total investment limit from US$15 billion to US$20 billion, and c) allow firms in the manufacturing and infrastructure sector that have FX earnings to avail of external commercial borrowings for both repayments of existing rupee loans undertaken for capital expenditure as well as fresh rupee capex spend.
Though the measures such as increase in FII limit for government securities markets and ECBs should attract flows over the medium term, these measures in no way attack the fundamental macro-economic problem of fiscal deficit in India.
We think what is required to change the sentiment around the rupee is market reforms and measures towards fiscal tightening - such as fuel price hikes. As such, the current measures by themselves fall well short of market expectations and by themselves, are unable to change the sentiment towards the rupee.