MUMBAI India raised import taxes on gold and silver on Tuesday as policymakers scrambled to narrow a gaping current account deficit, but concerns about the slowing economy and fears of more capital outflows kept up pressure on the ailing rupee.
The rupee got a small lift after the gold measures were announced in late afternoon, after earlier threatening to test record lows.
Finance Minister Palaniappan Chidambaram unveiled plans on Monday to curb imports and raise capital inflows to relieve the grinding pressure on emerging Asia's worst-performing currency.
But the measures have largely underwhelmed investors due to a lack of specific details.
India's broader aim is to narrow the current account deficit to 3.7 percent of gross domestic product (GDP) in the fiscal year ending in March 2014, down from a record 4.8 percent in the previous fiscal year, Chidambaram told parliament, a goal many analysts said was optimistic.
But market participants fear India's piecemeal approach of raising a couple billion dollars here and a couple of billion there will not be enough to arrest the rupee's decline at a time when the economy is weakening and prospects of foreign outflows grow on the back of a rollback in U.S. stimulus.
Without a more ambitious plan to tackle the current account deficit, analysts say the Reserve Bank of India (RBI) may need to stick to its gambit of draining cash from the financial system longer than expected, risking further strains on the economy and, in turn, making it harder to attract vital foreign inflows.
"These measures need to be backed by structural reforms. Unless the fundamental woes are addressed, any sustained relief in the rupee will be temporary," said Anubhuti Sahay, economist at Standard Chartered Bank in Mumbai.
The rupee recovered somewhat after the announcement of the gold and silver import tax hikes to trade at 61.12 to the dollar. It earlier fell to as low as 61.66 per dollar, not far from the record low of 61.80 hit on August 6. It has lost more than 10 percent so far this year.
GRAPHIC: Rupee, bonds, implied FX yields link.reuters.com/gaw89t
ALL THAT GLITTERS
India hiked the import duty on gold to a record 10 percent, the third such increase in eight months, while also raising excise duty on the metal.
Gold is India's biggest luxury import and was a key contributor to the all-time high in the current account deficit.
The move comes as imports of gold revived to $2.9 billion in July after a series of tax hikes and constraints on supplies had initially appeared to stem demand, confirming the resilience of demand in the world's biggest buyer of bullion.
Analysts also fear that duties on gold may just increase smuggling.
Cutting oil import bills - another component of Chidambaram's plans on Monday - may be a tougher task given the weakening rupee is pushing up domestic fuel prices.
India also has yet to provide details about its plans to impose duties on non-essential items, such as electronic goods, which would need to be carried out without breaking World Trade Organization rules.
"This piecemeal and stop-gap approach to addressing a real problem risks backfiring as it undermines investors' confidence," said Sonal Verma, economist with Nomura in Mumbai.
LOOKING FOR DOLLARS ABROAD
India also hopes to attract $11 billion in capital inflows by spurring state-run companies such as Indian Railway Finance Corp Ltd to sell debt abroad, and by raising money from Indians abroad, among other measures.
But the fundraising would be done in an uncertain global economic environment, and at a time when growth remains weak.
For example, Indian Oil Corp (IOC.NS), which is expected to raise $1.7 billion, last month sold 10-year dollar-denominated debt by paying about 50 basis points more over equivalent U.S. Treasuries than in its last sale in July 2011.
Economic data remains discouraging. Figures on Monday showed industrial output declined a larger than expected 2.2 percent in June from a year earlier.
Fears about the U.S. Federal Reserve's plans to taper back its monetary stimulus have sparked strong foreign selling in many emerging markets, especially in debt. Foreign investors have sold a net $11.6 billion of Indian debt and equities since late May, when the rupee started its decline.
"A strategy to sustainably reduce the current account deficit - the fundamental problem - is missing and the focus remains on garnering more debt inflows to finance the current account deficit," Nomura said in a note to clients.
"This strategy has already been tried and tested over the last few years and has resulted in the country accumulating larger external liabilities - the price of which is being paid now. More of the same is unlikely to result in a different outcome."
Even if the government does whittle the current account deficit down to 3.7 percent, it is still above what the RBI has called a sustainable deficit of 2.5 percent of GDP.
(Additional reporting by Subhadip Sircar and Siddesh Mayenkar in MUMBAI, Nigam Prusty in NEW DELHI, Neha Dsilva from IFR in HONG KONG, and A. Ananthalakshmi in SINGAPORE; Editing by Kim Coghill)
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