Rupee closes at new low, bond yields at 15-month high

MUMBAI: Indian bonds rose to a 15-month high of 8.55% and the rupee dropped to a new alltime closing low on Wednesday, hours after yields on 10-year US treasuries rose to a near two-year high of 2.7%.

The rise in US bond yields triggered fears that foreign investors may again be pulling out of Indian funds. The sentiment weakened further with official data showing that wholesale prices in July rose to a five-month high of 5.7%. This fuelled concerns that interest rates may remain high for longer than expected.

The rupee dropped to a new all-time closing low of 61.44 per dollar on Wednesday. It had touched a life low of 61.80 on August 6.

“I feel the rise in 10-year bond yields is a knee jerk reaction contributed by substantially higher domestic inflation in July and rise in yields on US treasuries,” said NS Venkatesh, head, treasury, IDBI Bank. “If measures to curb the rupee’s fall are rolled out immediately, we could see the yields coming back and settling at 8.25%. In a matter of 2-3 weeks, we should see some dollar inflows, as a result of the measures the government and the RBI take, which should support the rupee.”
India’s current account deficit, the difference in the value of its imports and exports, is mostly being funded by shortterm capital flows, which may reverse if the US Federal Reserve chooses to pull back on the bond purchases of about $85 billion a month, signalling a tighter monetary policy and higher interest rates regime in the US. This may reduce the risk appetite of foreign investors who have so far invested in Indian papers for their higher returns, against near zero interest rates in the US. India’s current account deficit in FY13 stood at 4.5% of GDP.

The Indian government is expected to announce more measures to address the dollar scarcity in the system, possibly through a sovereign bond issue or by restricting dollar outflows and making inward remittances attractive.

India on Tuesday increased import duty on gold and silver in a bid to discourage imports of the metals. It had imported $18-billion worth of gold in the quarter ended June.

The central bank on Wednesday cut the locals’ overseas remittances to $75,000 a year, from $200,000, and prohibited investments in overseas property, eliminating chances of further Indian contribution to the real estate recovery in the US and Europe.

In order to keep rates on Indian debt instruments attractive for foreign funds, and curb the slide in currency, the Reserve Bank of India introduced measures to tighten liquidity and keep shortterm interest rates high in June, by capping the amount that banks can borrow from RBI on a daily basis to 0.5% of total deposits and asking banks to maintain cash reserve ratio (CRR) at 99% of the total CRR requirement on a daily basis. CRR is the proportion of deposits banks must keep with the RBI.

But these measures have hardly helped. The rupee has lost 11% since May 24.