RBI fights back for the Rupee

At Rs 52 per dollar, the rupee has lost over 16% on a YTD basis, in what is its 3rd-worst fall over the past 2 decades. To fight against this trend, the RBI took some steps on Nov 23, 2011, like raising the interest rate for foreign currency deposits and the cost ceiling on External Commercial Borrowings (ECBs), and liberalising currency swap hedging limits for companies. These measures are expected to result in some kind of appreciation of the rupee against the USD.

Following this announcement, the rupee is currently trading at 52.20 against the dollar, stronger than Wednesday’s (Nov 23) close at 52.36. However, we feel the measure taken by the RBI will achieve its full impact over the medium term, and the rupee could continue to remain volatile in the near term.

The RBI increased the interest rate for Non-resident External (NRE) term deposits and Foreign Currency Non-resident Bank (FCNRB) deposits. The spread over LIBOR rates for NRE term deposits were increased by 100 bps to 275 bps, while for the FCNRB rates they were increased by 25 bps to 125 bps. The move has come into force with immediate effect, and will attract foreign investments, which in turn, will increase the demand for the rupee in the market.

The central bank also raised the cost ceiling for the external commercial borrowing. All-in-cost Ceilings over 6 month LIBOR for the average maturity period of 3-5 years has been increased by 50 bps to 350 bps, while the cost ceiling was unchanged for the average maturity period over 5 years at 500 bps. The proceeds of the ECBs raised abroad for rupee expenditure in India should be brought immediately for credit to rupee account, while ECB proceeds meant for foreign currency expenditure can be retained abroad pending utilisation. The rupee funds will not be permitted to be used for investments in capital markets, real estate or inter-corporate lending. These amendments in ECB policy will come into force immediately, and the enhancement in all-in-cost ceiling is applicable up to Mar 31, 2012, and subject to review thereafter. The move will restrict Indian companies from borrowing overseas money, which will be costlier now onwards.

The RBI also removed the cap of USD 100 million on foreign currency swap transactions. This move will help banks sell more currency swaps to companies with overseas debt at a time when the currency movements are volatile. In other words, a company which has an exposure to foreign currency loans will swap the transaction against the rupee loan. Companies will be willing to transact in such a manner because the rupee has depreciated quite a lot. On the other hand, there will be demand for rupee, which will help it appreciate further.

However, we feel that there will be no sudden inflow of foreign deposits in the country. Also, companies are not in the mood to raise funds for expansion because of the economic slowdown. The clear impact of the move could be visible only over a period of 3-6 months.