August 7, 2007 / 1:27 PM / 12 years ago

India tightens foreign debt rules to stem inflows

NEW DELHI (Reuters) - India tightened rules on foreign borrowing by local firms on Tuesday, saying loans of more than $20 million must be spent overseas, in a move analysts said aimed to check capital inflows that have pushed the rupee higher.

Incoming capital into India’s fast-growing economy, from overseas debt as well as portfolio and direct investment, has given the Reserve Bank of India (RBI) a headache by pushing up the rupee and complicating monetary policy management.

The rupee has risen about 10 percent to a nine-year high of 40.20 per dollar this year, making it the Asian currency which has gained the most against the U.S. unit in 2007, and its appreciation has drawn complaints from exporters.

But analysts said Tuesday’s move, which takes effect immediately, was unlikely to weaken the rupee straight away, and further steps to stem high capital inflows might still be needed in coming months.

“It looks like this is just one more measure taken by the Indian authorities to slow capital inflows and bring down the level of liquidity in the economy,” said Keith Gyles, international economist at Capital Economics in London.

“The authorities will probably have to take more measures to cool the economy over the next few months,” Gyles said.

The finance ministry said in a statement that Indian firms wanting to raise more than $20 million overseas will only be able to use the proceeds abroad.

Companies borrowing up to $20 million would need the RBI approval for spending the funds locally.

The changes, which come into immediate effect, do not apply to borrowers who have already entered into loan agreements.

External commercial borrowings doubled to $16.1 billion in the fiscal year to March 2007 from the previous year. In May, the RBI tightened rules on the end-use of foreign borrowings by local firms for real estate, by withdrawing an exemption granted to development of integrated townships.

DRAIN LIQUIDITY

The RBI has been intervening to keep the rupee down by buying dollars and injecting rupees into the market. But the resulting surplus cash is potentially inflationary at a time when policy makers are also trying to keep a lid on inflation.

Last week it raised banks’ reserve requirements to 7.0 percent from 6.50 percent to drain extra cash from the system, and analysts do not rule out further increases this year.

But it held interest rates steady so as not to attract further funds into the rupee.

“It was becoming increasingly difficult to tackle capital inflows coming from overseas,” said Shubhada Rao, chief economist with Yes Bank. “Monetary policy does get compromised due to rising flows.”

Asia’s third-largest economy grew by 9.4 percent in the fiscal year to March 31, its fastest pace in 18 years, but the growth was accompanied by a surge in prices.

After five increases in the short-term lending rate since June 2006, most recently in late March, headline inflation is now below an annual rate of 5 percent from a two-year high of 6.69 percent in January, but demand remains robust.

Tuesday’s announcement was made after market close, when the rupee ended at 40.41/42 per dollar, and traders did not see it making an immediate impact.

“It would make the RBI’s job easier to prevent a sharp appreciation of the rupee. But we don’t see the rupee weakening tomorrow itself,” said Paresh Nayar, chief dealer with Development Credit Bank.

Additional reporting by Anurag Joshi and Charlotte Cooper in MUMBAI and Rajkumar Ray in NEW DELHI

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