As India tightens the screw on cash availability in the banking system to ward off speculative pressures on the wobbly rupee, companies and stock investors are facing turbulent times with the tough monetary measures lighting a fire under borrowing costs and stamping out any prospect of reversing a sharp economic slowdown soon.
The iron-fisted moves, which included draining out the rupee equivalent of billions of dollars and hiking the emergency funding rate by 300 basis points, make bets expensive against the rupee by big players such as banks and institutions. The measures have helped strengthen the Indian currency to 59.05 for one US dollar at Friday’s close from an all-time low of 61.21 struck on July 8.
There is a heavy price to pay, however. The cost of commercial papers used by companies to raise short-term cash has shot up by more than
200 basis points, while the yield on 10-year government bonds has jumped about 100 basis points forcing the central bank to offer sharply higher yields at its debt auctions.
“Policy-makers are trying to achieve a fine balance by squeezing liquidity at the short-end even as they try to cap yields at the long-end,” JPMorgan said in a note to its clients. “Yet, some transmission to long rates, funding costs and investment decisions is inevitable.”
For the manufacturing and services sector, struggling with a decade-low economic growth of 5 per cent, the monetary tightening could spell big trouble. Rising costs and collapsing demand have already blown a hole into corporate finances, triggering defaults or rescheduling of loan repayment to banks.
Risky strategy
The fundamental reason for the rupee’s slump — of more than 10 per cent in about two months — was due to a record current account deficit that ballooned to 4.8 per cent of GDP, or nearly $90 billion, at the end of financial year in March. This was primarily because India’s import bill was rising at a faster slip than export earnings.
A subdued global economy and New Delhi’s policy paralysis were the major contributing factors. The Reserve Bank of India’s tightening strategy to defend the rupee is fraught with risks, does not address the root problem and could potentially make the situation a lot worse.
“Choking off liquidity seems to be the standard solution for every problem that confronts the central bank,” Siddhartha Roy, economic adviser to the Tata Group, argued in an article in the Mint newspaper.
“The relationship between lower liquidity, higher interest rate, and lower growth seems to have been forgotten; the damage it can do to the capital markets and investor confidence does not seem to matter.”
On previous occasions when crisis emerged — in 1991, 1998 and 2000 -— New Delhi had taken the lead and launched bonds or deposit schemes through the government-run State Bank of India targeting the Indian diaspora spread across the world. The government now says similar plans, including a proposal for a sovereign bond offering, are on the table.
Obviously, this begs the question: What’s holding up the decision?
Although there are no answers forthcoming from the government, there are enough instances to show that the mandarins from the finance minister to the chief economic adviser and other policy wonks were slow to grasp the gravity of the situation quickly.
When the rupee began to slide around mid-May, New Delhi was in self-denial and the talking heads called it a “knee-jerk” reaction, claiming India’s growth rate despite having nearly halved in a span of three years was still far superior to the developed economies and hence the rupee should regain its poise.
It was a false sense of bravo and the markets, with a greater feel of the economic pulse, called the bluff. As New Delhi faltered in creating the climate for foreign investment and boosting growth, the RBI stepped in with the series of unexpected tightening measures because it has only limited ammunition to defend the rupee.
“Unless the RBI mobilises $15-20 billion by issuing NRI bonds or sovereign debt, as we expect, INR will likely breach Rs65/$ in 2014 as it can barely sell $30 billion to fight contagion,” DSP Merrill Lynch said in a report.
RBI policy
When the RBI meets on Tuesday for a scheduled quarterly policy review, it will be faced with a Catch-22 situation. Doubtlessly, the central bank is concerned about sluggish growth and is likely to leave the repo rate — the main policy rate — unchanged at 7.25 per cent. It is also unlikely to raise the 4.0 per cent cash reserve ratio.
The tightening measures put in place over the past two weeks, which have not touched the policy rate and the reserve ratio, are expected to stay for at least three months. So, all eyes will be on Governor D. Subbarao’s comments about the outlook.
It is not just the industry that is upset with the RBI’s subtle ways of putting the squeeze on credit flows, the measures have stirred a hornet’s nest for commercial banks too.
“Hike rates if you want, but do not choke liquidity,” SBI Chairman Pratip Chaudhuri said in a speech, and added with a tinge of sarcasm that the central bank should act in a “frank, fair and transparent manner”.
For the top-30 Sensex that fell 2 per cent in the week to Friday and the broader 50-share Nifty which shed 2.4 per cent, the near-term outlook is subdued. Some of the earnings due in the coming week are:
ICICI Bank, Bharti Airtel, NTPC, UtraTech Cement, Dr Reddy’s Lab, Reliance Communications, Bank of Baroda and Idea Cellular.
The writer is a journalist based in India
