Blasé Capital Saving Rupee

In several columns on this page, we presented a warning. While the central bank’s aggressive moves, even archaic in the age reforms, to staunchly and unequivocably support the rupee may work in the short term, they may result in a freer fall later. Indeed, after the weekend when the crunching limits on short positions were imposed, the rupee slumped below INR 95, and only strengthened after a series of extra and stringent moves were imposed immediately. The rupee recovered, but still behaved like an ailing patient. The Reserve Bank of India (RBI) won the crucial battle but one is not sure about the state of war.

Experts cite several reasons why the rupee may be under more pressure in the future. The first is that an impression has gained ground that the RBI is possibly “stepping back” from reforms, and its intent for deeper integration with the global financial markets. Since the moves hint at what happened in 2013, more than a decade ago, these are being thought of as retrograde steps, which is pushing the central bank into a closed-door room, where currency protection is

paramount. This may flush out genuine and honest traders, and leave the rupee to battle it out

between the aggressive regulator, and never-giving-up speculators.

Some economists feel that the decisions, coming as they did after more than decade, may undo years of openness. One of them said that they “essentially break the link RBI had cultivated in the last decade.” The fact is that no one, not even the most nationalistic traders, expected the central bank to go this far. This is how closed economies function, or how Malaysia reacted after the Asian currency crisis. This is not how a confident, growing, and prosperous emerging economy reacts. Investors’ faith in reforms, market moves, and similar jargon may shake.

Another side effect, but crucial implications of the rupee becoming stronger from over-INR 95 to a dollar to under-INR 93, relate to the impending losses to the banks, and hedging becoming more expensive. The unwinding of short positions may cost some of the banks several millions of dollars each. Expensive hedging means higher costs, and difficulty-in-doing business, which is contrary to the aims and desires of the policy-makers. As investors protect their positions, they cut back their exposure to bonds, which creates complications. If global investors, and institutions shun the rupee, or give hints, there are more problems.

Look at the open reactions of some of the experts. One of them told a newspaper that the scale of intervention, and lack of communication raised concerns over transparency. The RBI’s actions were “discretionary,” which stinks of the times when policies are opaque, nationalistic, and aimed to protect the policy-makers and regulators. Some feel that the recent actions “raise the bar for rupee assets among offshore investors.” Indeed, there may now be a divide between onshore and offshore trading, which may not be a good sign. Even if the moves are reversed, the taste will linger on for a long time.

Media reports indicate that nations, which have imposed such strictures in the recent past have suffered. Between 2015 and 2017, China tightened the offshore yuan liquidity, which “steadied the currency but led to funding pressure, and unsettled global investors.” In 2016, Malaysia’s restrictions on offshore currency trading “reduced the speculative activity but drained liquidity.” Hence, there is invariably a “delicate balance” between currency protection at any cost, which is what India did, and reforms-oriented image, which India gave. Even minor discretions can break the bond, and severe links.

When he spoke for the first time after the currency moves, which is when he unveiled the monetary policy, Sanjay Malhora, RBI governor, explained that the measures were temporary, and not permanent. The finance ministry leaked information that global experts, including foreign investors, were consulted before the measures. The first indicates signs of

reconciliation, or an admission that this was knee-jerk reaction to prevent the rupee from breaching INR 100 to a dollar. The second hints that the idea was not to spook investors.

“Some analysts believe the central bank’s actions may provide only limited support to an economy dealing with a current account deficit, and capital outflows. Elevated oil prices could further strain inflation, and widen the deficit, adding to pressure on the rupee. For now, restrictions… have reduced liquidity, and made hedging more challenging. The growing divergence between offshore and onshore markets is already affecting foreign appetite for Indian bonds,” explains a media report. The fact remains that investors need a “reliable and predictable investment framework.” They cannot be jolted with shocks.

More importantly, short-term aggression, and guerrilla attacks, like the RBI did, cannot win wars. Yes, they win battles, as the RBI did, and rupee strengthened. If the macro scenario does not change, the speculators will be back, and with a vengeance. In the end, what the RBI will achieve is a steady fall, not necessarily a plateau. Possibly, this is what the central bank wishes. It does not want a sudden and steep fall. Indeed, as the RBI has maintained, it does not have a support level for the rupee. Its aim is to stop speculation that drives the rupee lower, and faster, and more aggressively, than it is expected to do.