The rupee rallied sharply over the week-end after a touching a low of 72.91/$ to close at around 71.85/$. Even the 10-year bond yield tapered on expectation that the weekend package to revive the rupee would do away with the need to hike rates for the RBI. But the package announced by Arun Jaitley, was patchy and slightly utopian in nature. First let us look at the highlights of the package.
What the package does?
The so-called rupee package announced by Arun Jaitley is rather long on intent but fairly short on delivery. Firstly, the package will review the mandatory hedging condition for infrastructure loans. The package will also allow the manufacturing companies to access the ECB market up to $50 million with a 1 year maturity rather than a 3 year maturity. This concession could be a ticking problem for the markets and in the event of any sharp fall in the rupee it will only lead to a rush to cover. Effectively, it will only exacerbate the problem that it was intended to resolve. The package will only remove the limit of 20% of FPIs to bonds of a single business group. This is unlikely to give a boost considering that FPIs have their own internal checks and balances. Lastly, the package tries to boost the Masala Bond market by exempting from withholding tax. Masala bonds are rupee bonds and they will be in demand only if the INR is strong and stable. Also the challenge of group funding remains.
What about the NRI package?
The rupee falling by 14% since the beginning of the year is not a normal event. It is clear that the INR is under tremendous pressure after the trade deficit and the CAD have reached levels of discomfort. What was expected by the market was a clear signal to NRIs to invest in India via a special deposit scheme. What India requires at the current juncture is a quantum push to dollar inflows and not some stop gap measures. The rupee is unlikely to get any relief out of these moves. Like in 2013, in the midst of a currency crisis, the government should have gone ahead and announcement a special NRI deposit scheme at an attractive rate. That would have immediately stemmed the fall in the INR.
What if CAD touches 3%?
The big challenge for the government is the CAD touching the psychological mark of 3%, which could most likely happen in the second half of the year. That would put pressure on the INR and also on the external ratings. With oil prices likely to stay buoyant, the oil import bill will not see any let-up. Add to that, if the US Fed again hikes rates in September then we could see another bout of risk-off flows. The measures announced may at best be a sentiment booster for the INR. With limited leeway for the RBI to intervene, these measures may be too half-hearted! ©