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  • Why Govt's forex measures may not be enough to stem rupee fall

    Publish Date: September 18, 2018

    With over 13% depreciation in its value against the US dollar, one would think the Indian rupee has had enough of a battering. Yet, the domestic currency seems to plumb new depths each passing day, with 73 against the dollar well in sight now. There has been intense pressure on the Indian government to do something about this as the rupee became one of Asia’s worst-performing currencies. For a net importer country, a weaker currency is bad news. Finally, over the weekend the government came out with a multi-pronged prescription to cure the malaise. The measures are aimed at increasing capital flows and reiterating the commitment to stick to fiscal deficit targets. But structural challenges and adverse global conditions will keep the risks of INR depreciation alive.

    Bittersweet pill

    Currencies do not live in silos. The minute-by-minute updates that affect the global economy have impacts on currencies as well. When a currency, be it Rupee, Dollar, or Yen, is driven by external factors, there is little to do. At such a time, the government as the steward of the economy is expected to soothe frayed nerves. The Indian government, after much dilly-dallying, finally announced a slew of measures. These include allowing banks to underwrite and market masala bond issues, and an exemption for this year on the 5% withholding tax.

    The government also removed the issuance-specific restrictions for foreign portfolio investors (FPIs) looking to invest in corporate bonds and eased rules to allow infra companies to hedge their forex liabilities. Manufacturing units too were allowed better access to external commercial borrowing (ECB) opportunities. Put together, these moves try to address the demand and supply side issues of the currency market. Don't be surprised if another set of steps is announced soon. At a difficult time, the onus is on the government of the day to maintain macro stability while fixing the underlying structural issues. But will this be enough?

    Related: What is driving the rupee: Everything you should know

    Alter falter

    We feel that the steps announced by the government will reduce friction in doing business or investing in India. However, they may not transform the movement of the rupee. At this moment, India is not witnessing the quantum of inflows that is required to turn the sinking rupee around. None of these measures is expected to increase flows into the country over the near term. That's the bitter truth we need to accept.

    Yes, the sentiment may change a bit. That is reassuring, but it is more important that such a sentiment boost is sustainable. We feel the negative sentiments around the rupee are likely to mitigate in the near term given the clear focus of the government to bridge the current account deficit funding gap. Buoyant direct tax revenues and overshooting its divestment target are positives. At the same time, capital expenditure targets are not been tinkered with, which is a positive.

    Related: Will the five-pronged government strategy steady the Indian economy?

    However, there are reasons to be sceptical too. Investors must keep a close watch on the pace and quality of revenue and capital expenditure.

    Another key monitorable would be revenues from the Goods and Services Tax (GST). The fiscal math will be dependent on this. GST revenue collection dropped to Rs 93,960 crore in August, down from Rs 96,483 crore last month, hitting the lowest in the current financial year 2018–19.

    Lastly, the progress on divestments is crucial too. The central government may stick its neck out and actually protect its targets. But states in election mode and 2019 being a general election year could pose real risks of slippage.

    External evil

    We believe structural challenges and adverse global conditions will keep the risks of rupee depreciation alive. There are too many things going on, and the rupee being part of a connected global economy cannot remain isolated for long.

    The monetary policies of developed markets are a key risk. As the central banks unwind monetary policies, emerging market economies will have to pay a price.

    The constant chatter of trade wars and higher crude prices are not helping. Reports always talk about how the US President is likely to impose fresh tariffs against China. Meanwhile, Asian currencies are weakening against the dollar. The US Fed members are sounding more hawkish with fiscal support being provided to the US economy. Plus, dollar liquidity is shrinking and that is negative for emerging markets and their currencies.

    Related: Rupee's fall in value against the US dollar: What can the government do?

    To have a permanent shield, India needs to improve its savings profile. Only this can help it manage its external sector risks in a better way. This means that if macroeconomic risks are to be mitigated, the aggregate demand needs to slow down. That's not good for the economy. As the global economy enters a period of adjustment from the winding up of easy monetary policy in developed markets, emerging markets have to brace for pain.

    As a result of all these factors, the rupee can cause heartburn even if the Indian government pulls out all stops to let it appreciate.

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