RBI measures on capital flows is a signal to speculators, but they may not increase flows materially
The gathering strength of the US dollar, persisting weakness in the rupee and the deteriorating external balance seems to be weighing heavily on the Reserve Bank of India (RBI), and rightly so too. This is reflected in the slew of measures to improve capital flows announced on Wednesday. Given the negative impact of a weak rupee on inflation, the central bank is right in taking proactive steps to strengthen the currency. Such actions send a signal to the forex market that the central bank is battle-ready to defend the currency, thus deterring speculators.
But the high level of uncertainty surrounding global economic and financial conditions make it doubtful if these measures will have the desired effect of improving capital flows.
RBI has announced three sets of measures to augment domestic dollar supplies. One, domestic banks have been incentivised to source more NRI deposits by doing away with the requirement to maintain additional reserves for incremental deposits over the next four months. The existing interest rate restrictions on FCNR (B) and NRE deposits have also been waived until October 31.
Though the strategy to woo FCNR(B) deposits brought in over $26 billion during the taper tantrum episode in 2013, it was largely due to RBI taking on the currency risk by offering a swap at a fixed rate of 3.5 per cent per annum. With banks expected to take on currency risks this time, it remains to be seen if this draws similar interest.
Two, the framework for FPIs to invest in domestic bonds has been loosened until October 31. The range of G-secs offered under the Fully Automated Route has been enhanced, FPIs are now allowed to invest in corporate money market instruments and to hold more than 30 per cent of their portfolio in bonds with less than 1-year maturity. Effectiveness of this measure is however questionable with a major chunk of FPI investment limit in debt securities currently remaining unutilised.
The negative real interest rates in India coupled with the higher risk of depreciation of the rupee, renders these securities unattractive.
Three, the limit for India Inc to borrow automatically through the External Commercial Borrowing (ECB) route has been doubled with the rate cap for this raised by 100 basis points, over the existing ceiling of 550 basis points. This could allow lower-rated companies to tap foreign currency loans, though it is moot whether this move is beneficial for smaller companies.
The RBI is clearly worried about the double whammy it is facing in the external account – sharp increase in current account deficit and a large reduction in the capital account surplus due to FPI outflows. There are expectations that the current account deficit for FY23 could be around 3 per cent of GDP and the overall balance of payment could turn into a deficit of over $60 billion. The central bank can, however, go a little slow from here and not resort to further knee-jerk measures.
If the sharp decline in crude oil and other commodities prices this week sustains, it will ease the pressure on CAD to a great extent. Also, if the US slips into recession, FPI flows into Indian equities could revive, given the relatively better growth prospects here. As for the rupee, it would be best to let it be, restricting interventions and policy actions to periods of high volatility.
Published on July 07, 2022