The RBI Forex Stimulus: Positive But Feeble

Economics
The rupee has been falling quite drastically since the beginning of this fiscal from Rs 50.57 to Rs 56.53/$ on June 25th 2012. The fall by 11.8% on a point to point basis, exhibited annualized volatility of 10.5% with the exchange rate crossing the Rs 57 per dollar psychological mark last week. The government had announced that it would be introducing some measures to strengthen the forex market. Table 1: Exchange rate
58

Exchange rate: Rs/$

June 25, 2012

57 56 55 54 53 52 51 50 3-Apr-12

1-May-12

8-May-12

15-May-12

22-May-12

29-May-12

The options open to the government which were a part of the discussion matrix were: Introduction of a Indian forex bond like the IMDs (India Millennium Deposits) and RIBs (Resurgent India Bonds) Freeing of FCNR rates More FII investment in debt segment More liberalized ECB norms Easier access to export credit Higher FDI norms in some sectors

In essence it was expected that the government would cover all or some aspects of the balance of payments to strengthen the forex reserves. Forex reserves stood at $ 289 bn as on June 15 th 2012, which is around $ 5 bn lower than it was on March 31st2012. This can be attributed to deterioration in fundamentals as well as sale of dollars by the RBI. (In April, which is the latest month for which information is available, the RBI sold $ 275 mn).

10-Apr-12

17-Apr-12

24-Apr-12

5-Jun-12

12-Jun-12

19-Jun-12

Economics

Against this background, the measures announced by the RBI are the following measures: 1. It has been decided to allow Indian companies in manufacturing and infrastructure sector and having foreign exchange earnings to avail of external commercial borrowing (ECB) for repayment of outstanding Rupee loans towards capital expenditure and/or fresh Rupee capital expenditure under the approval route. The overall ceiling for such ECBs would be USD 10 billion. Impact: While this measure is positive for companies in the infra sector, the forex risk that is associated with such borrowings also needs to be kept in mind when using this facility. Given that the rupee has depreciated by 20-25% over the last year, the implicit advantage of using the ECB route will be qualified. 2. The existing limit for investment by Securities and Exchange Board of India (SEBI) registered foreign institutional investors (FIIs) in Government securities (G-Secs) has been enhanced by a further amount of USD 5 billion. This would take the overall limit for FII investment in G-Secs from USD 15 billion to USD 20 billion. It has also been decided to allow long term investors like Sovereign Wealth Funds (SWFs), multilateral agencies, endowment funds, insurance funds, pension funds and foreign central banks to be registered with SEBI, to also invest in G-Secs for the entire limit of USD 20 billion. The sub-limit of USD 10 billion (existing USD 5 billion with residual maturity of 5 years and additional limit of USD 5 billion) would have the residual maturity of three years. Impact: While this move is definitely positive for FIIs, the impact may not be significant in terms of bringing in the dollars. Presently, as of March 2012, FIIs had held 0.88% of outstanding GSecs. Outstanding GSec debt was Rs 25.1 lkh cr which amounts to around Rs 22,000 cr or $ 4 bn. Considering that the existing limit is still there which has not been exhausted, the current changes would improve the flows, albeit only marginally. 3. The terms and conditions for the scheme for FII investment in infrastructure debt and the scheme for non-resident investment in Infrastructure Development Funds (IDFs) have been further rationalized in terms of lock-in period and residual maturity. Impact: This will be beneficial provided there are more infrastructure schemes being invoked. The IDFs have had a slow start so far and hence, these rationalization measures, while helping may again not bring in a slew of dollars. 4. Qualified Foreign Investors (QFIs) can now invest in those mutual fund (MF) schemes that hold at least 25 per cent of their assets (either in debt or in equity or both) in infrastructure sector under the current USD 3 billion sub-limit for investment in mutual funds related to infrastructure. Impact: This measure is again positive, provided these funds are looking at India in a big way and within that the infrastructure sector. Unless there are big bang reforms in this area, it is unlikely to have more than a marginal impact.

The RBI Forex Stimulus

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Economics

Concluding remarks: The measures announced by the RBI are on the whole positive. But they will not improve sentiment (the market has reacted negatively) or fundamentals in a significant manner. For this to happen, the market requires measures that would bring in around $ 20-30 bn in the near run. None of these measures will create this kind of an environment. Under these circumstances, the rupee will continue to be under pressure.

Contact: Madan Sabnavis Chief Economist madan.sabnavis@careratings.com 91-022-67543489

Anuja Jaripatke Associate Economist anuja.jaripatke@careratings.com 91-022-67543552

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The RBI Forex Stimulus

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