Govt’s move to relax overseas debt curbs for firms and allow foreigners to buy more local debt is not likely to provide the weakening rupee the kind of support it needs as underlying economic conditions worsen. By opening up to more capital inflows, policy makers hope to take some pressure off the rupee, which has fallen more than 7 percent this year, and help control inflation.
Analysts say the move is unlikely to result in a flood of inflows as global market turmoil and the risk of a widening budget deficit dulls the lure of Indian debt, and slowing growth and rising inflation are longer-term weights on the rupee.
"It won’t make a huge difference. The move is largely symbolic and shows the central bank is increasingly worried with the rupee’s continued weakness," said Robert Prior-Wandesforde, an economist at HSBC in Singapore.
India raised foreign investment limits in government and corporate debt to $5 billion and $3 billion, respectively, from $3.2 billion and $1.5 billion, and allowed firms to borrow up to $100 million abroad and repatriate the funds, from $20 million earlier.
That was a turnaround from nine months ago, when authorities clamped down on offshore borrowing by firms to try and rein in the rupee as it rallied to its strongest in nearly a decade. It was also a shift in the central bank’s currency policy, now looking to guard against sharp rupee weakness having bought almost $100 billion in the 15 months since the start of 2007 trying to contain it.
"A FX policy that is weakening the currency is, over time, inconsistent with an overall policy regime that is seeking to curb inflationary pressures," HSBC’s Wandesforde said.
RUPEE WOES
The rupee was trading around 42.6 per dollar on Wednesday, stronger than a 13-month low of 43.21 per dollar hit in May but well below last year’s close of 39.41. Calyon expects the rupee to fall as low as 44 per dollar by September due to growing risk aversion, deteriorating balance of payments and rising political uncertainty.
The rupee last traded at 44 per dollar in March 2007. Annual inflation hit a 3-1/2-year peak of 8.1 percent in mid-May, above the central bank’s comfort-zone of 5.5 percent, and an expected increase in state-set fuel prices, expected to be announced on Wednesday, may push it closer to double digits. According to HSBC research, oil prices in rupee terms have risen 46 percent since April 1
Oil is the country’s biggest import item, and record global prices have upped demand for dollars from refiners and raised worries about a widening trade deficit, a negative for the rupee. On Friday, the central bank said it would provide refiners with foreign exchange against special oil bonds the government issues them as compensation for selling at below-market prices.
JP Morgan estimates the Reserve Bank of India may end up giving as much as $12 billion to refiners, only a small part of its $316 billion of foreign exchange reserves but an indication of policy makers’ increasing discomfort with a falling rupee.
BOND WOES
At the same time, the cost to the government of subsidising retail fuel prices is likely to increase supplies of, and dampen the appetite for, debt. The quasi-sovereign bonds do not appear in the government’s budget deficit calculations, although the government is responsible for the coupon and principal payments.
Morgan Stanley estimates that the total fiscal deficit including off-budget subsidies and national and state deficits at 9.4 percent of gross domestic product in the 2008/09 fiscal year (April-March), up from 7.7 percent in 2007/08. Along with inflation, risk aversion and a weak rupee, that was likely to push 10-year bonds yields to 8.75-9.0 percent in six months, Morgan Stanley said.
The yield was at 8.1 percent on Tuesday. "We are not bullish on Indian paper at the moment because Asian central banks including the RBI remain behind the curve in inflation fighting, and the fuel price issue is not going away," said Edwin Gutierrez, a debt fund manager at Aberdeen Asset Management who manages $5.5 billion in emerging market debt.
Allowing companies to borrow more from the overseas markets could reduce their borrowing costs by 200-400 basis points, but analysts say inflows via this route are unlikely to pick up sharply as global market conditions make borrowing harder.
Central bank data showed net offshore borrowings by firms was $16.3 billion in April-December 2007, about one-fifth of net inflows in the period. Lehman Brothers expects net capital inflows to fall to $56.7 billion in 2008/09 from an estimated $99 billion in 2007/08, with the balance of payment surplus shrinking to $18 billion from $85 billion. "(As long as) oil prices remain elevated, inflation remains high and there are concerns on growth, the rupee will continue to remain on a weak wicket," said Shuchita Mehta, economist at Standard Chartered Bank.
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