Battle for Rs 60/USD: BofA-ML's 3 event risks to watch out next week

NEW DELHI: The recent slide in rupee and its consequences have sent the markets plummeting, escalating fears of a downgrade, thereby deepening apprehensions of a steeper economic slump. While policymakers and the Reserve Bank of India have come up with last-ditch measures to stem the rupee volatility, little seems to have changed.


While doling out liquidity tightening measures in the July-policy, the RBI Governor, D Subbarao admitted that global factors weigh heavy against the rupee, and there is limited scope for monetary intervention. As steps taken by the RBI prove counter-productive, the collateral damages, in terms of stunted economic growth over long term and Bank Nifty taking a hit, seem to loom large.

In the current backdrop, a Bank of America Merrill-Lynch research report cites three major eventualities in the next week that could change the course of events.

Firstly, a slew of short-term measures have been promised by the government and the RBI over the weekend, which could arrest the rupee fall. The report asserts that the rupee volatility would continue unless the RBI does not recoup its FX reserves, especially on account of the differential with the US Fed, which has already widened to 700 bp. Although, there is room for more rate cuts, the report categorically stresses on the need to retrieve forex reserves for rupee to stabilize.

Secondly, the monsoon session of the Parliament gears to clear some key reforms, like the pension and land acquisition bills, with an agenda to give some leverage to the economy, by opening pathways for foreign investors to invest in sectors like insurance and realty.

Furthermore, to mitigate the effects of rupee depreciation, the government may allow external commercial borrowings (ECBs) for: (1) corporates repaying INR debt; and (2) PSU banks for capital raising.

It could hike the caps of the less-than-3 year tenor to $300 million from $20 million and the automatic route (of up to 5 years) to $1.5 billion from $750 million. Finally, Indian arms of MNCs could be allowed to raise working capital from their parents.

Thirdly, the report notes, if RBI's current liquidity tightening measures are not rolled back before the October-March period, then the GDP growth for FY14 could fall to 4.8%. The report recalls that June industrial production is expected to contract by 1%.

In fact, RBI's tightening measures will only sustain deposit growth below loan demand. Infrastructure industries production has also slowed down to 0.1 % from 2.3% last month. The HSBC PMI is down to 50.1 from 54.7 in December.

Although, July CPI inflation at 9.8%, remains elevated with floods disrupting supply lines. At the same time, with WPI inflation at 5%, the retail food prices, barring onions, are peaking off. Good rains have led to an 11.6% jump in sowing. Tight monetary policy has helped reining in core inflation, if not stemming the rupee fall.

However, analysts believe that currency manipulation is a moot endeavour, given that global pressures are beyond the limits of any manoeuvring by monetary authorities. Moreover, the rupee fall is not the result of speculation, as assumed by the RBI, but a symptom of a larger fundamental economic problem.

Administering superficial issues like the rupee slide would only deny focus to the more systemic problems, namely the huge current account deficit and rising inflation.