I was on small vacation to my home town during the first half of the week and RBI made the big news by announcing several steps to stop the slide in the Indian rupee on Monday, which hit a record low of 61.21 last week. RBI came under severe criticism let’s try to analyze in 10 points the action and effects:-
1) RBI has increased the Marginal Standing Facility (rate at which banks borrow from the RBI using their statutory liquidity ratio securities as collateral) rate. So far, banks (bearish on the rupee) borrowed from call money markets and bought dollars in the forward markets expecting the dollar to rise. Since, borrowing short-term money will now be costlier; banks will most likely cut their forward positions and reduce speculative trading. This will reduce pressure on the rupee.
2) RBI has capped the amount banks can borrow from overnight markets to Rs. 75,000 crore. The RBI will also conduct Open Market Sales of bonds of Rs. 12,000 crore on Thursday. These measures are aimed to suck liquidity from the system. Bond prices will fall and yields will rise. Higher yields will attract foreign investment back into the debt market at a time when FIIs have sold billions of dollars ever since the U.S Fed signaled a tapering of the quantitative easing.
3) The new steps were announced after RBI’s earlier steps to sell dollars in forex markets through state-run banks failed to halt the slide in the currency. Moves taken to curb speculative trading last week helped the rupee snap a nine-week losing streak, but the currency slipped below the psychological 60 mark again on Monday, necessitating more steps.
4) The Indian rupee jumped over 1 per cent to 59.13 in early trades on RBI measures. The measures are “a classic textbook response”. These steps will tighten domestic liquidity, raise short-term interest rates, increase the relative interest rate differential and possibly stem debt outflows.
5) As expected, bond yields jumped sharply, with yields on 7.16% 2012 bond edging above the 8 per cent mark.
7) There is a risk that today’s measures could backfire. “India‘s growth is already very weak and tighter domestic liquidity will worsen the financial conditions for corporate and banks, hurting asset quality and the growth outlook,”
8) There are fears that current moves may succeed in stemming debt outflows (helping the rupee), but growth-sensitive equity flows will be at risk. So, stock markets will fall further, with banking stocks at the highest risk. If the higher rates were to persist and impact GDP growth then that would impact the entire banking system negatively. The Bank Nifty slumped over 4.5 per cent lower, underperforming the broader Nifty
9) This move will impact the banks and NBFCs in two ways. One, directly through net interest margins (which will fall) and two, indirectly through the impact on GDP growth, Yes Bank traded with over 8 per cent cut, while IndusInd Bank shares shed 7 per cent.
10) These measures are unlikely to send the rupee in a permanent upward trajectory. The government needs to address fundamental problems such as high current account deficit.