Care Ratings today released a report titled ” Rupee’s reaction to policy and news” which looks at the rate of rupee depreciation and impact on the country. The report analyses the impact of news and the current policies of the Reserve Bank of India on the Rupee – Dollar rate.
Rupee Depreciation 2013 Impact on Country & Economy
Rupee depreciation has come to become one of the most crucial concerns for the Indian economy, particularly in the last two months. There has been concerted effort at limiting the depreciation from all quarters, be it intervention of the monetary authority (RBI), the Government (Ministry of Finance) or the capital markets regulator (SEBI).
The RBI, specifically in the last two months, has been proactive in managing depreciation of the rupee. While it has clearly stated that its flexibility to directly enter the forex market is limited by the size of the country’s forex reserves, the monetary authority has opted for a slew of ancillary measures to cap the fall of the rupee.
Despite such interventions, there have been only temporary relief bouts and the rupee continues to remain in the range of Rs 59-60 to a dollar. This leads us to question the effective change in the rupee rate that these measures have been able to induce.
Annexure 1 provides a snapshot of the slew of announcements that have been made in the months of June and July and its impact on the rupee.
What do we observe?
- The rupee during these two months has seen the sharpest depreciation (of 96 paise) on a daily basis (based on RBI reference rate) on June 19, 2013, following early indications of the FOMC tapering QE3.
- The absence of easy money and ample liquidity as provided by the Fed with its unlimited bond-buying programme and accommodative monetary policy stance sparked sudden fear in the minds of investors. Multiple rounds of the QE programme had been supporting both advanced and emerging market economies and an earlier-than-expected tapering of the same came as a shock to global investors. While the Fed has now clarified that it will continue with the QE programme, tapering cannot entirely be ruled out and investors appear to be factoring in this uncertainty more explicitly now.
- The highest appreciation of the rupee during this period (of 98 paise), on the other hand, came a day after the RBI announced easing of rules for non-bank asset finance companies to raise to overseas debt.
- During this period of two months, there has been no clear-cut reversal in the direction of change in rupee rate against the dollar (the exception being 25th July where the rupee went into the Rs 58.90-59 range). Measures such as gold import duty rise, restrictions on lending against and tightening of liquidity have caused the rupee to inch up only marginally on a day-to-day basis.
- Starting the first prominent series of announcements on June 6, 2013, when the RBI reference rate for rupee settled at Rs 56.87 to a dollar, till the most recent measure announced on July 24, 2013 when the exchange rate settled at Rs 59.44 to a dollar, the rupee has depreciated 4.5%.
An obvious conclusion to draw here would be that these measures have had limited impact on the rupee. But, to the extent these measures have worked they have ensured that the pace of depreciation has been checked and the rupee has ranged between Rs 59-60/$. However, the impact on sentiment has been more discernible. Reactions of FIIs and banking stocks to rupee-related news have been captured in the following two exhibits.
Exhibit 1 charts daily net FII inflows a day after announcements by RBI (most ‘news’ have been released after market hours and reactions of FIIs would be reflected on the following day) and Exhibit 2 charts daily changes in BSE S&P Bankex (over the previous day) on account of ‘news’ –
- Net FII inflows have mostly been in the negative territory during the last two months. FIIs withdrew substantially on days after the RBI announced extension in buyback time period of FCCBs, tightened gold lending norms for RRBs and restricted daily liquidity by capping available funds under the Liquidity adjustment facility (LAF) to Rs 75,000 crore and raising short-term rates.
- Contrary to this trend, net FII inflows were positive a day after the July 23, 2013 announcement that allowed for further tightening of liquidity in the banking system. It may be conjectured that investor expectations of earning arbitrage profit on the back of tighter monetary policy and higher interest rates in local markets could have prompted this move. It remains to be seen if such inflows would be sustained in the coming months.
- The BSE bankex dipped as investors presumably exited banking stocks post-announcements of RBI allowing deferment of payment of forex option premium, easing norms for low-cost builders to raise ECBs and non-bank asset finance companies to raise overseas debt. The bankex unexpectedly picked up, moving to the positive zone once SEBI announced stricter exposure norms for currency derivatives and stayed there seemingly on the back of some banks announcing better-than-expected Q1 FY14
- With the July 23 announcement that further curtailed individual bank access to LAF and increased CRR requirements, the bankex dipped substantially as the move would directly impact banks’ business activity, which has already been subdued over the past two years
Impact on Liquidity
Along with directly targeting the rupee rate, the RBI in its July 15, 2013 announcement also looked at steps to squeeze out liquidity. The following three steps had been outlined –
- The MSF rate was recalibrated upwards by 300 bps to 10.25%, also implying that the bank rate automatically moved up to 10.25%
- The overall allocation of funds available under LAF was limited to 1% of NDTL of the Indian banking system i.e. to Rs 75,000 crore, each day (with effect from July 17, 2013), and
- An OMO sale of Rs 12,000 crore was simultaneously announced
These measures suggested a withdrawal of liquidity from the banking system, which immediately reflected in a drop in repo borrowings by banks from the RBI under the LAF window (Exhibit 3).
A day prior to the restriction in available repo under LAF came into effect; borrowings by banks were seen to shoot up, presumably in a rush to shore up funds before the squeeze.
A conjecture in this scenario would be that volumes in the call and CBLO market would have shot up during this phase of lower permissible repo borrowings. However data does not clearly support this hypothesis. Volumes in both call and CBLO market have maintained previous levels.
On July 23, 2013, the RBI made another set of announcements targeting liquidity in the banking system –
1. The overall limit for access to LAF by each individual bank is now set at 0.5% of the bank’s own NDTL outstanding (as on the last Friday of the second preceding fortnight); effective from July 24, 2013
2. The minimum daily CRR balance to be maintained by banks has now been elevated to 99% on a daily basis (from the previous 70%); effective from the reporting fortnight beginning July 27, 2013
3. Auction of cash management bills to the tune of Rs 6,000 crore
On examining the movement of repo borrowings, we notice repo borrowings increasing once again on July 23 (a day before the measure came into effect). Liquidity visibly dropped the following day on account of lesser access to repo under LAF. With the auction of cash management bills a further withdrawal of liquidity is expected. The RBI had last auctioned cash management bills two years ago in 2011, and were amply subscribed.
The impact of the change in minimum CRR balances is not expected to be very pronounced. Despite the earlier norms of 70%, banks in general have been maintaining balances close to 98%, on certain days the same being even greater than 100%. Hence, while the 99% stipulation would now have to be met mandatorily on a daily basis, banks are not expected to run into a crunch of funds to be diverted towards CRR requirements.
Where are yields and interest rates headed?
Short-term interest rates however, peaked on the day following RBI’s announcements of July 15, 2013. The weighted average call rate (overnight) rose 1.3%, while the 1 month Tbills rate rose 2.0%. CP rates as well rose in the range of 1.5% – 2.0%. The immediate impact on the long-term 10 year GSec rate was less pronounced, rising just 0.5%. A week after RBI’s announcement too short-term interest rates remain elevated (although lower than the immediate reaction noticed on July 16, 2013). The 10-year GSec yield has remained stable at 8.0% (Table 1).
A similar surge in rates was observed a day after the July 23, 2013 announcements. Given that this set of measures, was once again a direct hit on liquidity, the impact on short-term rates was higher. The weighted average call rate rose 1.9%, the Tbills rate rose 1.6% (for 1 month residual maturity) and 1.8% (for 3 months residual maturity). CP rates rose in the range of 1.1% – 1.2%, while the 10-year GSecs yield rose 0.3% over the day.
Rupee Future Forecast – 2013
Implications and Expectations
- The path of sustained monetary easing appears less likely now, given that the RBI has now turned hawkish in its stance to cap depreciation of rupee and limit the widening of CAD. Inflation, particularly imported inflation is expected to move upwards, but only at the margin.
- The rupee is expected to face pressure during the year and movement in exchange rate would be range-bound; the Rs 59-60 to a dollar being the new normal for the rupee rate.
- CARE expects a rate cut of 50 bps in H2 FY13, in two tranches (more likely towards November- December), highly contingent on dynamics of rupee depreciation, CAD and inflation. An adverse data input on any of these macro-variables would be viewed strictly by the RBI and a rate hike scenario cannot entirely be ruled out.
- While these measures may be viewed as temporary, the hike in short-term interest rates would defer banks decisions to cut lending rates in the immediate run.
- Credit disbursement may hence, be expected to continue in is subdued phase for a while and would likely settle lower than expected in FY14 again.
- Yields across maturities are expected to firm up and CP and CD funding rates would be no exception. This could accentuate the problem of a low investment cycle at the macro-level as firms once again move to sidelines in CP issuances, largely used to finance working capital.
- The 10-year GSec could will be under pressure until further guidance is received from the RBI and the rupee stabilizes. The range of 8.3-8.5% looks more likely in the very short run and the Policy statement later this month will provide further direction. While these measures appear to be temporary, with a motive to stabilise the rupee; the RBI would be reviewing them from time to time. Hence, the direction and magnitude of change in interest rates becomes crucial. Attaining normalcy in terms of exchange rate and RBI policy reversals would take the yield back to the 7.5- 7.6% range, though the timing is uncertain.
- Short-term rates for CP and CD in such a scenario could very well range in double digits for some more time. Any reversal in current moves by the RBI is almost immediately expected reverse the impact on both long-term GSec yields and short-term interest rates.
- Until such time that domestic interest rates remain high, Indian corporates could be prompted to access the ECB/FCCB market to a greater extent depending on the interest rate differentials and currency risk.
- This however, could pressure the country’s external vulnerabilities in coming months; an impending threat to the CAD, especially in an environment of withdrawals of foreign investments that could potentially finance the CAD.