RBI steps in to shore up Re, but economy could take a hit

Move Targets Speculation, Pinches Cos

Mumbai: In its toughest step to defend the rupee after the Lehman Brothers crisis in 2008, the Reserve Bank of India (RBI) has moved to push up short-term rates in the money markets which will choke speculators and attract dollars to India. But these measures will cause collateral damage to the economy by pushing up shortterm borrowing for companies by a couple of percentage points and cause huge losses for bond investors. 
    In a late-evening statement on Monday, the RBI said that it would limit its lending of overnight funds to banks to Rs 75,000 crore. If banks need more they will have to pay a higher interest rate of 10.25%. 
    Bankers say an immediate outcome of this will be that the cost of overnight funds will cross 10% as their current overnight borrowing is over Rs 93,000 crore. 
    This, in turn, will translate into higher short-term borrowing for companies. The sensex which crossed 20,000 points on Monday on hopes of a rate cut triggered by lower inflation could lose its gains as hopes of a rate cut have vanished. 
    The measures were announced after RBI governor D Subbarao rushed to Delhi on a day when the Prime Minister and finance minister held meetings, ostensibly to address the exchange rate issue amid dwindling foreign exchange reserves. 
    On Monday, despite stringent trading restrictions by the RBI, the rupee lost 27 paise to close at 59.90 after touching over 61-levels last week. 
    "The market perception of a likely tapering of US quantitative easing has triggered outflows of portfolio investment. Consequently, the rupee has depreciated markedly in the last six weeks. Countries with large current account deficits, such as India, have been particularly affected despite their relatively promising economic fundamentals," the central bank said in a statement. 
SHORT-TERM PAIN, LONG-TERM GAIN? 
MEASURES 
Overnight banks borrowing from RBI capped at 75,000cr 
Additional borrowing to be at 10.25% 
RBI to sell bonds worth 12,000cr to make rupees scarce 
Bank rate raised from 8.25% to 10.25% IMPLICATIONS 
Hopes of an interest rate cut dashed as RBI sacrifices short-term growth for rupee stability 
Rupee-$ exchange rate may stabilize 
Cost of overnight funds in money markets could cross 10% 
Bond prices will crash as investors expect better returns 
Mutual fund schemes that invest in bonds will take a hit 
Cost of short-term borrowing for corporates to rise 
Widespread speculation in forex, especially dollars, could be curbed RBI to ease steps if Re stabilizes 
Mumbai: The exchange rate pressure also evidences that the demand for foreign currency has increased visa-vis that of the rupee in part because of the improving domestic liquidity situation," the RBI said. 
    "In the short-term liquidity will be at a premium. Banks may have to cut the cash drawing limits for corporates. Some banks may come out with measures to shore up short-term money. Stock markets will be affected as well as some investors may have to liquidate assets," Pratip Chaudhuri, chairman of SBI, told TOI. 
    According to Harihar Krishnamurthy, head of trading at First Rand Bank, the measures will have wider implications on the economy as cost of funds would go up. But the measures are likely to be relaxed if the rupee stabilizes. Bankers said that RBI's observation show that it is convinced that some of the pressure on the rupee is because of speculators building positions in dollars in hope that it will appreciate further. "The main motivation appears to be to make the rupee more attractive vis-à-vis investments in the dollar. The measures will benefit the rupee which will gain as foreign institutional investors see an opportunity to invest in short-term debt. But at the same time this could have longer-term ramifications for the Indian economy," said Ashish Vaidya, head of fixed income currency and commodities trading at UBS. 
    RBI said that it has raised the interest rate under its marginal standing facility by two percentage points. The MSF is an emergency lending mechanism by which banks get funds when they exhaust their regular limits which have now been collectively capped at Rs 75,000 crore. On Monday banks had borrowed Rs 92,320 crore from RBI. From Wednesday their borrowing stands limited to Rs 75,000 crore—a move which will set them scrambling to raise the Rs 18,000-crore shortfall. The shortage of funds could increase if the RBI chooses to price the Rs 12,000-crore bonds at rock-bottom level in Thursday's auction. 
    "RBI has stuck with a hammer. Bond and equity markets are sacrificed to protect rupee and its adverse impact on the economy; short-term pain for long-term gain," said J Moses Harding, head of economics and market research, in a tweet.