Financial Tsunami in the making

It is tough to navigate against strong headwinds......tough times ahead!

RBI is looking at all options to “lead” foreign currency supplies and “lag” foreign currency demand (into the FX market) to arrest run-away rupee weakness which will lead to hard landing of the Indian economy. In its effort to limit excessive one-way move; repeated rounds of interventions have not yielded desired results as rupee is already down from 48.61 (31^st October) to 52.73 (22^nd November) at an alarming rate of 8.5% in short span of time (annualised rate of over 140%). It is unfortunate that RBI is left to fight against strong headwinds both from domestic and external sectors. While the fundamentals are very weak triggered by low growth; high inflation; tight liquidity and high interest rates, the structural woes are severe. The market stake holders are already in dollar oversold mode driven by leading of export receivables; lagging of import payables; uncovered short term carry trade flows and un-hedged interest cost reduction structures shifting rupee liability to dollar liability. RBI rolled out measures to pull in dollar flows from foreign investors through relaxation in investment norms such as higher limit; new products and no restriction on residual maturity. Given the very low investor appetite with foreign investors; there is no tangible benefit from these measures.

There will be more such measures in pipe-line having already lifted the cap of USD 100 mio net supply position to enable companies to increase their “short dollar” positions. The merit of this move will not be known now; as further rupee depreciation will add to financial woes of these companies. The pipe-line measures should target addressing dollar liquidity squeeze and supply side issues. More important ones are deregulation of FCNR/NRE rates and lifting of “cap” on off-shore borrowing limits for Banks. These can provide instant results with low lag time. What can be the impact of these measures on the rupee? It can definitely result in reducing the momentum to the fall. But for some of the measures already rolled out, rupee would have posted another historic low above 53.50; thus has prevented things moving from bad to worse. The reversal from bad to good is not going to be easy given the weak fundamental and structural dynamics of the domestic and global economy.

The strong headwinds are there to stay for more time, may be 6-12 months. The immediate concern for RBI would be to arrest spread of currency woes into money market. There is already risk of overnight MIBOR shooting past 9% ahead of trigger of additional LAF counter (at 1% above Repo Rate). This would mean that call money rate can move into double digit by second fortnight of December when advance tax outflows hit the system. It would be extremely difficult for RBI and the Government to arrest simultaneous downward pressures from equity; currency and money markets while struggling to address low growth; high inflation issues. The rough ride so far since July 2011 is becoming tough and difficult to navigate. It may not be a financial Tsunami in the making but need to tighten the belts to avoid damages from hard landing!

Moses Harding