MUMBAI/NEW DELHI (Reuters) - India announced steps on Monday to bolster the embattled rupee, including a $5 billion increase in the foreign investment cap in government bonds, but disappointed markets hoping for bolder action to prop up a currency that hit a record low on Friday.
After the central bank raised the bond limit to $20 billion and announced other relatively minor steps, the rupee trimmed gains built up earlier in the day on hopes for more aggressive moves. Stocks tumbled.
"Well, not the 'shock and awe' the market was looking for but we shall see what else gets announced. Not surprised to see dollar/rupee higher," said Jonathan Cavenagh, senior forex strategist at Westpac in Singapore.
"Until they address longer-term structural issues around capital flows and competition in the domestic retail sector which can help bring down inflation pressures, I think markets will be left disappointed," he said.
The steps were the latest by Indian policymakers trying to combat a loss of confidence in the economy, which slumped in the March quarter to its worst growth in nine years.
The rupee has hit a succession of record lows this year in a slide that began in the middle of 2011. It has fallen about 7 percent this year, making it the worst performing currency monitored daily in Asia by Reuters.
After the rupee hit another record low, Finance Minister Pranab Mukherjee said on Saturday that steps to arrest the slide would be unveiled on Monday, spurring rampant market speculation.
The comments from Mukherjee, due to step down on Tuesday so he can run for the largely ceremonial post of president, seemed to catch India's policymaking establishment off-guard.
Three finance ministry officials ordinarily in the loop on such plans said at the weekend that they were unaware of the pending measures.
At the finance ministry in New Delhi, officials rushed in and out of a meeting for more than three hours. At one point a participant said officials were themselves trying to "figure out" what to do.
"Once again, the government unnecessarily raised expectations only to disappoint," CLSA economist Rajeev Malik said in a client note.
The rupee rose as high as 56.37 per dollar before the measures were announced but ended domestic trading at 57.01/02, edging back towards Friday's record low of 57.32.
The central bank stepped into markets late in the day to support the currency.
The BSE Sensex fell 0.53 percent, having traded higher on the day before the measures were unveiled.
"India's macro imbalances cannot be fixed by a patchwork of Band-aids or by applying balm," CLSA's Malik wrote.
Policymakers have come under intense pressure to revive the fortunes of the economy, which before the global financial crisis was growing closer to 10 percent a year.
However, growth declined to a nine-year low of 5.3 percent in the March quarter. Ratings agencies Standard & Poor's and Fitch Ratings are threatening to downgrade the country's credit rating to junk and foreign investors have exited as the government fumbled economic reform and raised the prospect of retroactive taxes.
Economists have long said India needs to improve its economic fundamentals, including addressing its current account and fiscal deficits, to bolster the rupee.
Critics say the government needs to cut back on fuel subsidies, which are stretching the fiscal deficit and lead to wasteful demand and therefore pressure on the current account and the currency.
"I don't believe these measures will do much to improve the currency situation, because the problem plaguing the currency are the twin deficits, and that can only be addressed by cutting the fiscal deficit. And that is a much tougher job," said A. Prasanna, economist at ICICI Securities Primary Dealership.
Morgan Stanley estimates India's current account deficit will widen to $72 billion by the end of June, from $49 billion a year earlier. That would put the current account deficit at between 4 percent and 4.5 percent of India's GDP.
"A sustainable solution would need a reduction of the current account deficit to around 2-2.25 percent of GDP with tighter fiscal policy, acceptance of slower consumption growth, and implementation of reforms that improve the business climate to encourage FDI inflows," the bank said in a Sunday note.
Other central bank measures on Monday included relaxing restrictions on how long foreign investors have to hold some government bonds, and the opening of investment in debt securities to more types of foreign buyers, adding sovereign wealth funds, central banks, pension funds and insurers to the list of eligible buyers.
India also reduced the minimum holding period for foreign investors in some long-term infrastructure bonds to one year from three years.
The measures may not generate significant new fund inflows because investors, wary of further weakness in the rupee, would bring in dollars only on a fully hedged basis, two traders at foreign banks said. They declined to be identified.
Other emerging market currencies have also weakened against the dollar as investors, worried about the global economic slowdown and the euro zone crisis, fled to the perceived safety of the U.S. currency.
But India's economy also has specific problems to overcome, economists say, which has added to pressure on the rupee. The government has struggled to garner political support for change, such as opening up the domestic retail market. Inflation also remains stubbornly high, largely because of supply bottlenecks in the economy.
India needs to shore up its credibility among investors, both in sticking to its projected fiscal deficit of 5.1 percent for the fiscal year ending March 2013 and to narrow its current account deficit, analysts said.
Standard & Poor's and Fitch Ratings have cut their outlook on India's sovereign ratings to negative, threatening its investment-grade status, citing a slowdown in economic reforms.
However, Moody's Investors Service said on Monday it was maintaining a stable outlook for India's Baa3 rating. It said slowing growth and higher levels of inflation were already factored into the outlook.
In a shot in the arm for the economy, Sweden's IKEA, the world's largest furniture retailer, said on Friday it would invest 1.5 billion euros to open 25 stores in India.
Additional reporting by Shamik Paul, Suvashree Dey Choudhury and Ross Colvin; Writing by Tony Munroe; Editing by Neil Fullick