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MUMBAI/NEW DELHI (Reuters) - Finance minister Chidambaram tried to talk up the rupee on Friday after it plumbed another record low on concerns the Reserve Bank of India's (RBI) latest measures to defend the currency could be a step towards outright capital controls.
Traders said the RBI was forced to step in to prop up the rupee as measures from the central bank late on Wednesday restricting how much Indian citizens and companies can invest abroad were seen as yet another roll of the dice that is undermining investor confidence.
Concerns that policymakers were losing control over the currency spread to the stock market, which dropped 4 percent, its biggest one-day decline in nearly two years.
Chidambaram told reporters that global developments, including the dollar spike after U.S. jobless claims data on Thursday, were behind the rupee falls.
"I have no doubt in my mind when calm is restored in the market, people will begin to understand that Indian market indicators must basically reflect Indian market conditions," Chidambaram said.
"I think this is time for calm. This is time for reflection."
Indian policymakers have cobbled together a slew of steps over the past month in a bid to halt the rupee's slide, including the central bank's extraordinary steps on July 15 to drain cash from the system and raise short-term interest rates in an economy already growing at a decade low.
Yet none of the steps or the rhetoric so far have convinced investors that India can attract overseas investments, which is seen as essential in narrowing a record high current account deficit that is the biggest source of the rupee weakness.
The approach is instead beginning to test the patience of foreign investors, just when emerging markets such as India are seen as particularly vulnerable to reduced cash inflows once the expected tapering of monetary stimulus by the U.S. Federal Reserve begins.
"They're coming across as a bit panicky. That's what is damaging sentiment for investors," said Jonathan Schiessl, a fund manager at Ashburton Investments in Jersey, referring to the RBI's actions to defend the rupee.
"Unless things improve, we will probably in all likelihood be withdrawing some weightings from our India positions."
The partially convertible rupee fell to an all-time low of 62.03 to the dollar as trading began on Friday. It ended the session at 61.65, weaker than Wednesday's close of 61.43/44. Markets were closed on Thursday for a holiday.
The prospect of the Fed stimulus rollback looms over India as the country struggles with a current account deficit that hit a record high of 4.8 percent of gross domestic product while its economic growth has slowed to a decade low of 5 percent.
Foreign investors have already sold a net $11.6 billion of Indian debt and equities since late May, sparking fears of further outflows.
India's benchmark 10-year bond yields surged to their highest since May 2012 on Friday.
"India is losing control over the currency and you are starting to see the weakness transmitting to stock markets. There could be a self-perpetuating cycle where currency weakness flushes out equity investors and that takes the rupee weaker still," said UBS strategist Manik Narain in London.
The RBI's restrictions on capital outflows are likely to delay overseas acquisitions and investment plans by India Inc at a time when many companies are scouting markets abroad to beat the domestic economic slowdown.
Yet the biggest fear is that the RBI's action could be the start of a far stronger move to restrain capital.
"The steps taken so far only target residents, but if this raises expectations that they could potentially resort to capital controls targeted at non-residents, that could have adverse near-term implications for capital flows," HSBC's Chief economist for India and ASEAN Leif Eskesen said.
"It will, therefore, be critical to tread very carefully when it comes to capital controls, to anchor expectations, and also not use it as a substitute for more appropriate and effective measures," Eskesen said in a note to clients.
As policymakers struggle to stem the rupee's falls, markets expect more weakness ahead. Overseas investors betting via one-month offshore non-deliverable forwards quoted the rupee trading at 62.46, while onshore bets see it 62.35.
A Reuters poll on Thursday showed short positions in the rupee had hit the highest in two months.
None of the measures unveiled by India so far have given markets assurance that the country can attract foreign flows in an increasingly difficult global environment, analysts said.
India last month unveiled plans to further ease restrictions on foreign direct investment (FDI) but previous measures have had mixed results. FDI fell to $36.9 billion in the fiscal year ending in March from $46.6 billion the previous year.
This week it announced measures to attract near-term capital inflows, including from state-run companies selling debt abroad.
Yet doing so could prove hard without major confidence-inspiring reforms, especially as RBI measures last month to drain cash raise the prospect that borrowing costs will rise.
"We remain underweight on Indian credits as the current spreads do not offer enough compensation in our view," said Arthur Lau, head of fixed income for Asia ex-Japan for Pinebridge Investments in Hong Kong.
Additional reporting by Swati Bhat, Subhadip Sircar, Aradhana Aravindan & Himank Sharma in MUMBAI, Umesh Desai in HONG KONG, and Sujata Rao-Coverley in LONDON; Editing by Kim Coghill and Susan Fenton