August 5, 2013 / 11:40 AM / 7 years ago

In struggle for clear message, policymakers harm rupee defence - traders

MUMBAI (Reuters) - Mixed signals from the Reserve Bank of India and the government over how to handle the fall in the rupee has contributed to its decline, investors say.

A security guard stands in the lobby of the Reserve Bank of India (RBI) headquarters in Mumbai July 30, 2013. REUTERS/Vivek Prakash

The RBI has appeared at times to contradict the thrust of its policy to try to stabilise the currency and also seemed at odds with the finance ministry, undermining market confidence in their resolve to tackle the problem, they say.

“The contradictions between the actions and voices from the central bank and finance ministry have aggravated the volatility in the market,” said Ganti N. Murthy, head of fixed income at Peerless Fund Management Co Ltd in Mumbai.

The partially convertible rupee hit a record low of 61.21 per dollar on July 8 and has hovered close to that level since. On Monday it traded around 60.8, down 9.6 percent this year, the weakest emerging market currency in Asia against the dollar among those monitored daily by Reuters.

A record current account deficit and a slump in economic growth in recent years to the lowest pace in a decade have undermined confidence in the currency. A government struggling to push through bold economic reforms ahead of a general election needed by May next year has added to investor jitters.

Traders say Indian authorities have tripped up a number of times, and that has contributed to the rupee’s weakness.

The central bank announced a bold strategy to tighten cash conditions in the middle of July, including a rise in short-term borrowing costs and restricting funds available for banks.

But within days it rejected all bids in a treasury bill auction and most bids in a special bond sale organised specifically to mop up cash. That seemed to run against its own efforts to tighten cash conditions and raised doubts about what the central bank wanted to achieve, dealers said.

At the time, sources familiar with the central bank’s thinking said the bids were rejected because they were too high. But as the rupee then continued to fall, the central bank changed tack.

The next week, it accepted all bids in a treasury bill auction at the highest yields in at least six years, helping lift the rupee to its strongest level in five weeks.

However, a few days later Indian markets were left with doubts again at the RBI’s policy review when Governor Duvvuri Subbarao said the central bank was ready to pare back its cash-draining steps once foreign exchange rates stabilised. The rupee skidded 1.8 percent, a large move for a currency.

“The market had begun to think that the RBI was serious about its rupee defence and the comments undermined that,” said Credit Suisse economist Robert Prior-Wandesforde in Singapore.

“It was like a classic case of a game of poker. The RBI had a reasonable hand and showed the market its hand,” he said.

The RBI did not have immediate comment when asked about its communication strategy.


At times, policymakers have also seemed out of tune with the market, dealers said.

The day after the RBI tightened cash conditions in mid July, Finance Minister P. Chidambaram sought to soothe concerns it was the start of broader monetary tightening. He suggested the economy would still grow by 6 percent in the year to March 2014, above most private estimates.

However, the central bank’s measures were quickly feeding through to longer-dated bonds, squeezing corporate access to funds and dimming the outlook for the wider economy. Since July 15, the benchmark 10-year-bond yield has risen more than half of a percentage point.

“While the finance ministry may like us to believe that these are not monetary tightening measures, let me be very clear that they are,” said R. Sivakumar, head of fixed income at Axis Mutual Fund in Mumbai.

The central bank says its aim is to manage currency volatility and it has insisted the government take measures to plug the current account deficit, which hit a record 4.8 percent of GDP in the financial year that ended in March.

Dealers say at times they received mixed messages on where policy is heading.

Last week, Subbarao poured cold water on the idea of India issuing sovereign bonds to help plug the current account deficit. The next day, Chidambaram said a bond sale was very much on the table.

When asked for comment on market confusion over finance ministry communication, a spokesman said: “It has been clarified on various occasions and platforms by the chief economic adviser and the finance minister himself about the government’s response to the rupee decline. There is nothing much to add at this moment.”

Investors have long suspected the RBI feels it can do only so much to support the rupee and is worried about depleting currency reserves that cover nearly seven months of imports, one of the lowest levels among major emerging markets in Asia.

Subbarao has appeared to acknowledge as much, saying in April that “a failed defence of the exchange rate is worse than no defence.

So far Chidambaram and India’s chief economic adviser, Raghuram Rajan, have said the government was looking at various options to narrow the current account deficit, such as partially curbing imports of non-essential items and easing rules on raising loans abroad.

Economists and traders say stronger and more immediate measures will be needed to support the rupee, such as raising domestic fuel prices to reduce imports.

“If you are sending a disruptive message to the market you should be prepared for a disruptive readjustment of the yield curve,” said Suyash Choudhary, head of fixed income at IDFC Mutual Fund in Mumbai.

Additional reporting by Archana Narayanan, Subhadip Sircar, Swati Bhat, Himank Sharma, and Suvashree DeyChoudhury in Mumbai and Manoj Kumar in New Delhi; Editing by Tony Munroe and Neil Fullick

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