September 5, 2013 12:39 pm

India rupee rallies on central bank move

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The battered Indian rupee and the country’s equities rallied on Thursday as investors welcomed measures by the new central bank chief to reverse an outflow of capital and liberalise the banking system.

On his first day as governor of the Reserve Bank of India on Wednesday, Raghuram Rajan unveiled plans to attract billions of dollars held abroad by so-called “non-resident Indians” (NRIs), to increase foreign borrowing by Indian banks and to give exporters and importers more scope to make forward foreign exchange contracts.

“The bottom line is that they want to increase the flow of dollars,” said Rajeev Malik, senior Asia-Pacific economist at CLSA.

The rupee, which has fallen sharply against the dollar in recent weeks ahead of an anticipated tightening by the US Federal Reserve of its ultra-loose monetary policy, rose over 2 per cent in early trading before falling back slightly to trade at Rs66.21 in the afternoon.

Investors received further encouragement from the approval by the lower house of a pensions bill that will allow foreign investment in pension fund managers, initially up to 26 per cent. Shares in Mumbai as measured by the Sensex index rose more than 2 per cent to 18,979.76, with the bank index up nearly 10 per cent.

Analysts said Mr Rajan’s measures would benefit the rupee in the short term but would need to be accompanied by broader economic reforms from the government – an unlikely prospect given the proximity of a general election due by May next year.

“Overall, the RBI’s reforms should be enough to help stabilise the rupee, particularly given that the global environment is likely to improve,” Daniel Martin of Capital Economics wrote in a research note. “Nevertheless, the outlook for India’s economy remains dire.”

Of the three main foreign exchange measures from Mr Rajan, the attempt to draw in dollars from NRIs is seen as the most important in the short term, with Morgan Stanley predicting that it could raise $5bn-$10bn.

Banks have been discouraged from offering attractive interest rates to NRI dollar depositors because of the high cost of hedging, but the RBI will now provide them with cover at 3.5 per cent a year, about half the current market rate.

“The irony is that essentially he’s increasing the flow of dollars by taking on more debt,” said CLSA’s Mr Malik. “NRI flows are technically overseas borrowing.”

Dollar flows could also be augmented by Mr Rajan’s doubling of the overseas borrowing limit for banks from 50 per cent of their unimpaired tier one capital to 100 per cent. Again the RBI is offering a hedging subsidy, allowing banks to swap into rupees at 100 basis points below the market swap rate.

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