Rupee Forwards Rally as India Flags Focus on Financial Stability

Offshore rupee forwards advanced the most in two weeks after the Reserve Bank of India said the nation’s economic and monetary policies must focus on preserving financial stability as the U.S. prepares to cut stimulus.

Weakness in the local currency, which tumbled almost 15 percent this year, could fuel already “high” consumer-price inflation, the central bank said in its annual report released in Mumbai yesterday. Asia’s No. 3 economy also faces risks from a current-account deficit that’s not sustainable, slowing growth, a budget gap and rising bad loans at banks, it said.

The rupee plunged to a record low and benchmark Indian bond yields surged to a 12-year high this week as the prospect of a reduction in the Federal Reserve’s stimulus fueled a capital flight from emerging markets. The RBI plans to buy long-dated government debt today in an attempt stabililze markets after rising volatility threatened to hurt an economy that is already growing at near the slowest pace in a decade.

“The RBI has no choice but to maintain financial stability at this point, which means sacrificing growth in the near term,” said Tirthankar Patnaik, a strategist at Religare Capital Markets Ltd. in Mumbai.

One-month rupee non-deliverable forwards strengthened 0.8 percent to 65.04 per dollar today, according to data compiled by Bloomberg. In the local spot market, the rupee touched an all-time low 65.56 per dollar yesterday. The yield on the 7.16 percent government bond maturing May 2023 has fallen to 8.24 percent from 8.90 percent on Aug. 16. The S&P BSE Sensex index lost 1.5 percent this week.

Rupee ‘Overshot’

Finance Minister Palaniappan Chidambaram and Reserve Bank Governor Duvvuri Subbarao held co-ordinated briefings in New Delhi yesterday to try to soothe investors’ nerves.

Excessive pessimism is unwarranted, economic expansion will pick up as the year progresses and the rupee’s drop has overshot appropriate levels, Chidambaram said.

India has no intention of imposing capital controls, he and Subbarao said. The Reserve Bank last week cut the amount Indian companies can invest abroad without approval and said residents can remit $75,000 per financial year, down from $200,000.

“Macroeconomic and monetary policies need to be carefully calibrated to achieve the immediate objective of maintaining stability without compromising growth,” the central bank said.

The monetary authority reiterated that the steps since mid-July to tighten liquidity “are intended to be rolled back in a calibrated manner” as the rupee stabilizes, so that policy can revert to supporting growth and containing inflation.

Tightening Measures

The Reserve Bank since July 15 has raised the marginal standing facility and bank rates, capped cash injections into the banking system and tightened lenders’ daily reserve requirements to curb the supply of rupees. On Aug. 20, it announced the plan to buy long-dated government debt.

“It’s a considered policy of the RBI that while we increase the interest rates at the short end in order to make it difficult for the speculators, we try to keep interest rates at the long end lower in order to promote growth and investment,” Chidambaram said.

The current-account gap may narrow in 2013-2014 from the record 4.8 percent of gross domestic product in the 12 months ended March, while remaining “much above” the sustainable level of 2.5 percent of GDP, the RBI said.

Chidambaram said last week curbs on gold and silver imports and plans to compress inward shipments of non-essential items will trim the current-account gap to $70 billion, or 3.7 percent of GDP, this fiscal year. He said yesterday the shortfall may be less than $70 billion.

Subbarao said India’s foreign exchange reserves are adequate to manage the current situation.

Bad Loans

The central bank also said in the report that “utmost attention” is needed to contain rising financial stability risks from deteriorating asset quality at banks.

The government began reforms in September 2012 to restrain the budget deficit, accelerate stalled infrastructure projects and ease restrictions on foreign investment in industries from aviation to retailing.

The administration is striving to avert a credit-rating cut that may hurt India’s ability to fund the trade imbalance.

Fitch Ratings said yesterday recent pressures on India’s markets aren’t a trigger for rating action at this point.

Consumer Prices

Consumer prices rose 9.64 percent in July from a year earlier, the second-fastest in the Group of 20 major economies. Wholesale prices advanced 5.79 percent, exceeding the central bank’s comfort zone of about 5 percent.

India’s $1.8 trillion economy will expand 5.5 percent in the year through March 2014, central bank estimates show, compared with a decade-low 5 percent in the previous 12-month period as investment moderated.

About 826 million of India’s 1.2 billion people live on less than $2 per day, according to the World Bank.

“Recovery is possible and can take shape later in 2013-2014, but is predicated on better governance, the removal of supply constraints and maintenance of stability,” the central bank said. Healthy monsoon rains augur well for agriculture and rural demand, the RBI said.

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