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Tuesday, July 16, 2013

RBI steps in to shore up rupee, but economy could take a hit

In its toughest move to defend the rupee after the Lehman Brothers crisis in 2008, the Reserve Bank of India (RBI) has moved to push up short-term rates in the money markets which will choke speculators and attract dollars to India. But these measures will cause collateral damage to the economy by pushing up short-term borrowing for companies by a couple of percentage points and cause huge losses for bond investors.

In a late-evening statement on Monday, RBI said that it would limit its lending of overnight funds to banks to Rs 75,000 crore. If banks need more they will have to pay a higher interest rate of 10.25%. Bankers say that an immediate outcome of this would be that the cost of overnight funds would cross 10% as their current overnight borrowing is over Rs 93,000 crore. This, in turn, would translate into higher short-term borrowing for companies. The sensex which crossed 20,000 on Monday on hopes of a rate cut triggered by lower inflation could lose its gains as hopes of a rate cut have vanished.

The measures were announced after the RBI governor rushed to Delhi on a day when the Prime Minister and finance minister held meetings, ostensibly to address the exchange rate amid dwindling foreign exchange reserves. On Monday, despite stringent trading restrictions by RBI the rupee lost 27 paise to close at 59.90 after touching over 61-levels last week.

"The market perception of a likely tapering of US quantitative easing has triggered outflows of portfolio investment. Consequently, the rupee has depreciated markedly in the last six weeks. Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals," the RBI said in a statement.

The exchange rate pressure also evidences that the demand for foreign currency has increased vis-a-vis that of the rupee in part because of the improving domestic liquidity situation," the RBI said in a statement.

"In the short-term liquidity will be at a premium. Banks may have to cut the cash drawing limits for corporates. Some banks may come out with measures to shore up short-term money. Stock markets will be affected as well as some investors may have to liquidate assets," Pratip Chaudhuri, chairman of SBI, told TOI.

According to Harihar Krishnamurthy, head of trading at First Rand Bank, the measures will have wider implications on the economy as cost of funds would go up. But the measures are likely to be relaxed if the rupee stabilizes. Bankers said that RBI's observation show that it is convinced that some of the pressure on the rupee is because of speculators building positions in dollars in hope that it will appreciate further. "The main motivation appears to be to make the rupee more attractive vis-a-vis investments in the dollar. The measures will benefit the rupee which will gain as foreign institutional investors see an opportunity to invest in short-term debt. But at the same time this could have longer-term ramifications for the Indian economy," said Ashish Vaidya, head of fixed income currency and commodities trading at UBS.

Announcing the measures, RBI said that it has raised the interest rate under its marginal standing facility by two percentage points. The MSF is an emergency lending mechanism by which banks get funds when they exhaust their regular limits which have now been collectively capped at Rs 75,000 crore. On Monday banks had borrowed Rs 92,320 crore from RBI. From Wednesday their borrowing stands limited to Rs 75,000 crore—a move which will set them scrambling to raise the Rs 18,000-crore shortfall. The shortage of funds could increase if the RBI chooses to price the Rs 12,000-crore bonds at rock-bottom level in Thursday's auction.

"RBI has stuck with a hammer. Bond and equity markets are sacrificed to protect rupee and its adverse impact on the economy; short- term pain for long-term gain," said J Moses Harding, head of economics and market research, in a tweet. The RBI statement said that it will continue to closely monitor the markets, the liquidity situation and the macroeconomic developments and will take such other measures as may be necessary, consistent with the growth-inflation dynamics and macroeconomic stability.

Source: TimesOfIndia


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