screwed

India’s central bank sacrifices growth to defend the rupee

July 16, 2013
July 16, 2013

The Indian central bank is running out of levers to pull to stabilize the falling rupee and the Indian economy.

In an attempt to boost the country’s currency, which has depreciated over 7% this year, the Reserve Bank of India (RBI) raised two lending rates by 2% each, limited access to the liquidity adjustment facility, and said it would drain 120 billion rupees ($2 billion) through open market sales of government bonds on July 18. This is the latest in a series of measures taken by the RBI, including banning banks from trading in currency futures.

The rupee’s precipitous fall pushed up the costs of imports, stoking inflation and exacerbating its current account deficit. Wholesale price inflation hit a three month high of 4.86% in June, while consumer inflation accelerated to 9.87%. The current account deficit stood at 4.8% of GDP at the end of the fiscal year that ended in March, considerably higher than the 2.5% level that RBI feels is sustainable. The rupee’s fall has also put pressure on corporations with unhedged foreign loans.

India’s actions follow similar moves by other emerging markets that are trying to brunt the impact of quantitative easing exit by the US Federal Reserve. China’s central bank induced a cash crunch that sent interbank borrowings costs to record highs; Brazil raised benchmark rates thrice this year; and Indonesia has been aggressively hiking rates since June.

Here are some of the ramifications of the RBI’s package for India’s economy:

1. Growth will slow further. 

The RBI’s measures could slow already meager growth to a decade low of 5% in the fiscal year that ended in March. Shortly after the announcement, Bank of America-Merrill Lynch cut its GDP forecast to 5.5% from 5.8% for the fiscal year ending March 2014.

2. Banks will be hard hit by rising borrowing costs. 

The RBI wants to tighten liquidity to prevent banks from using their rupees to speculate on the currency. But that also means pushing up the cost of buying commercial paper and certificates of deposit. Barclays estimates that overnight interbank rates could increase as much as 300 basis points.

3. RBI may be forced to hike interest rates. 

Analysts say the probability of a rate hike is rising. Goldman Sachs believes the latest measures constitute a “shift in monetary stance from pause to tightening” and that there’s a 33.3% chance that the RBI will hike rates in the July 30 policy meeting. The central bank had left the benchmark rates unchanged at 7.25% in June, ending a string of three cuts.

Despite the dangers, the RBI has few other options. Sajid Chinoy, a senior South Asia economist at JP Morgan estimates that India needs to raise at least $25 billion to prevent the rupee from falling further, but that it’s very difficult given “the current global environment of rising interest rates and a marked distaste for EM assets.” Direct intervention in the currency markets is impractical, as India has only enough reserves to cover seven months of imports.

India’s policymakers will keenly watch Fed Ben Bernanke’s testimony to the US Congress on Wednesday. If fears subside about the Fed winding down its easy money policy, the exodus of foreign funds from emerging markets will slow. That would likely do more to help the rupee than anything the RBI can do.

Top News

Powered by WordPress.com VIP
Follow

Get every new post delivered to your Inbox.

Join 24,449 other followers