Forex market tests RBI as rupee nears record low

By Rafael Nam and Swati Bhat

MUMBAI (Reuters) - The Reserve Bank of India (RBI) intervened to support the rupee on Wednesday as it neared a record low, but traders said the currency will likely fall further unless policymakers raise interest rates or the government takes steps to plug the gaping current account deficit.

The central bank's assurances on Tuesday that it will row back on the monetary tightening taken to defend the rupee once the foreign exchange market stabilises has acted as a red flag for currency dealers.

Analysts say the RBI will have to either put up policy interest rates - risking even slower economic growth - or squeeze rupee liquidity further to stop the rot. But even that would only buy more time as the country's external deficit eats away at the currency's value.

The rupee fell to as low as 61.17 to the dollar in early trade, not far from its record low of 61.21 hit on July 8, with month-end dollar demand from importers adding to the pressure. It closed at 60.47/48 on Tuesday.

The currency, which has lost nearly 10 percent of its value so far this year, was spared from an all-time low after the RBI was seen intervening starting at around the 61.17 level, traders told Reuters.

One-month non-deliverable rupee forwards hit a record low of 61.72, breaking the previous low of 61.70 hit on July 8.

"In the policy review yesterday, RBI kept rates steady but later commented that they are anxious and would like to roll back the high rates meant to support the rupee as early as possible," said Samir Lodha, managing director at QuantArt Market Solutions In Mumbai.

"The comment wasted all the efforts made by RBI recently since it shows RBI is unclear and doing things half-heartedly," he said.

Reserve Bank of India Governor Duvvuri Subbarao was due to take questions from analysts at 2:30 p.m. India time (0900 GMT) on Wednesday, while Finance Minister P. Chidambaram was expected to speak to the media at 3 p.m.

A lack of concrete details from the government to address a current account deficit (CAD) that hit a record high of 4.8 percent of gross domestic product in the last fiscal year is also eroding confidence in the currency.

Ultimately, responsibility lies with Prime Minister Manmohan Singh's weak coalition government to introduce credible measures to bring the current account deficit down to the 2.5 percent level that the central bank regards as sustainable.

BOND YIELDS RISE

Bond yields surged on Wednesday, further raising concerns that higher borrowing costs would hit an economy already growing at a decade low.

Yes Bank Ltd said on Wednesday it would raise its base rate by a quarter percentage point, setting up the prospect that bigger banks would follow through with similar increases.

"The pressure has been put back on the government to undertake structural reforms to bring the CAD down to sustainable levels," said Sacha Tihanyi, senior currency strategist at Scotiabank.

"We are not optimistic on this, and it may take a serious funding crisis before change can come," he said in a note to clients.

The volatility in the currency led bond yields to jump, with the benchmark 10-year yield up 8 basis points at 8.33 percent.

India's central bank left interest rates unchanged on Tuesday but sent the rupee lower by signalling it may withdraw the cash tightening steps taken so far in "a calibrated" manner.

Doubts about the RBI's resolve were then compounded after Subbarao poured cold water on the notion of selling a sovereign bond issue to attract foreign flows.

The government is considering a number of steps, including calling on its millions of non-resident Indians to bring in vital flows, but has yet to announce concrete measures.

Prior to the rupee's accelerated fall, the central bank's priority had been to support economic growth through an easier monetary policy stance, with successive rate cuts bringing the policy repo rate down to 7.25 percent, while banks' cash reserve ratio (CRR) was held at a record low 4.0 percent.

(Reporting by Rafael Nam, Subhadip Sircar, and Swati Bhat; Additional reporting by Archana Narayanan; Editing by Kim Coghill)