Convalescing rupee amid pragmatic reforms

The gradual rise in import duty on gold, luxury goods and non-essential items is set to reduce the imports. Some more measures to make imports costly are also in the offing

Dr Srinivasa Rao

The degree of stability of exchange rate of currency operating on a free float regime like in India reflects the pulse of the economy. That precisely is the reason why mandarins of financial sector are more concerned about the exchange rate stability rather than targeting a particular rate against international currencies, more particularly against the US dollar. Since May 22, 2013, the day US Federal Reserve indicated tapering of its ‘Quantitative Easing’ (QE) policy, the global financial markets have gone into a tail spin, its epicenter lying in emerging markets of Asia where the bulk of overseas funds stay invested. As a result, the Indian rupee depreciated by 16.1 per cent against the US dollar as on September 6. The cascading impact on stock markets led to a drop in Sensex by 5.4 per cent during the period. Depreciating from a level of Rs.54 for one US dollar, it touched a low of Rs.68.85 on August 28. Due to a series of pop up measures administered in the intervening period, it recouped to Rs.65.25 on September 6.

Among the slew of measures of the Reserve Bank of India (RBI) to revive the sagging rupee, the recent pragmatic reforms have been well greeted by the markets mellowing the upward streak. Moving fast towards the Rs 65-mark to a US $, the sentiments in the stock market are also inching up, led by bank stocks reviving the confidence of investors. There are distinct short-term tactical and long-term strategic measures that can better balance the demand and supply position of foreign exchange for providing long-term stability in the markets. The fact that the rupee appreciated by 5.22 per cent against a US $ between August 28 and September 6 indicates that some positive market sentiments are brewing.

Besides the earlier measures of liquidity curbs to prevent speculation in foreign exchange markets, some more short- term quick measures to ease pressure on demand for spot rupee include (I) introduction of RBI swap window to fresh FCNR (B) deposits mobilized by banks at a fixed rate of 3.5 per cent. Using such swap window, banks are expected to mobilize around US $ 10 billion of fresh deposits. (ii) Non- Deliverable Forwards (NDFs) were already introduced where the RBI sells the US $ directly to oil-importing companies to curb excessive demand for USD. (iii) Foreign borrowing limit of banks has been raised from 50 per cent of unimpaired Tier-I capital to 100 per cent, creating further elbow room for banks to raise additional overseas funds of US $ 30 billion. (iv) Exporters can now rebook cancelled forward exchange contracts to the extent of 50 per cent, importers to the extent of 25 per cent. (V) the reciprocal lines of swap window with Bank of Japan have been raised from US $15 billion to US $ 50 billion and review of such facilities with other trading partners is possible to infuse confidence in the markets. (vi) Non Resident Indians are also now allowed to acquire shares of listed Indian companies through the stock exchanges under Foreign Direct Investments (FDI) to step up inflows of foreign currency into India. (vii) The limit of US $ 2,00, 000 that an Indian individual can remit abroad annually for specified purposes has been brought down to US $ 75,000 to stem the outflow of foreign exchange. These quick measures are intended to reduce demand for the US $ and increase its supply side to lend stability to the market.

The gradual rise in import duty on gold, luxury goods and non-essential items is set to reduce the imports. Some more measures to make imports costly are also in the offing. Having crossed the exports level of US $ 300.60 billion in FY13, it is all set to hit the export target of US $ 325 billion in FY14. The rise in interest rate subvention on rupee export credit by the RBI from 2 per cent to 3 per cent can reduce exporter’s cost of borrowings of exporters and can consequently boost up the export potentiality. They can eventually reduce the current account deficit to a manageable level in FY14.

These multi-pronged measures should be able to tackle the volatility of exchange rates and be able to create an ecosystem for a sustainable exchange rate for the Indian rupee, much to the relief of interdependent stakeholders of the economy. In a globalizing economy the interconnectedness with the rest of the world is so intense that the events in the domestic economy get greatly influenced by external factors. Hence, the entrepreneurs trading in the globalizing markets have to learn the nuances of managing risks arising out of external factors.

These measures are supported by some of the long-term financial sector reforms. They include measures that are intended to foster more focused inclusive growth. In this league, henceforth (I) new bank licenses will be available on tap instead of opening up the banking sector in spells. (ii) Similarly, the opening of bank branches in Tier I centers, i.e. in large cities, will be freed. (iii) Banks’ investment needs in government securities in the form of Statutory Liquidity Ratios (SLR) will be reduced increasing lendable resources. (iv) Mobile and ATM network will be enhanced to cover more banking space.

Such a long-term approach in further modernizing the financial sector coupled with the focused approach in balancing forex inflows/outflows should be able to create a sustainable investor confidence in domestic and overseas markets. Hence, these pragmatic reforms with the concrete action plan of the RBI should be able to prepare the Indian economy to withstand the risks of global events when they actually happen.

The writer is the General Manager, Strategic Planning, in Bank of Baroda, Corporate office, Mumbai.

The views are personal.