RBI's latest measures may have steadied rupee, but risks far from over

RBI's incentives may attract short-term foreign inflows and ease pressure on the rupee, but they do little to address weak FDI and sustained foreign investor outflows

By Andy Mukherjee

  India has announced a raft of measures to revive global confidence in the sagging rupee. The best thing about the package announced Friday is what’s not in it: capital controls. 

During the 2013 currency crisis, authorities had slashed the dollar amount that individual savers could legally take out of the country in a year. This time, they wisely left the $250,000 limit untouched. Nowadays, when that money is widely used for everything from funding foreign education to buying stocks in the US and homes in Dubai, such a step would have been deeply unpopular.

 

It might even have backfired. The Reserve Bank of India has already made one big move to crush the buildup of speculative short positions in the rupee, though it had to be partially rolled back. The measure did nothing to dispel the negative sentiment around the exchange rate. In fact, it may have made things worse by signaling that the central bank was scraping the bottom of its traditional rupee-defence toolkit.

 

 

So instead of sticks, authorities decided to go with a carrots-only approach, telling state-run firms and local banks to raise dollars overseas, bring them home, and get a big discount on their hedging cost until Sept 30. Although I wasn’t expecting the RBI to once again subsidise the cost of external borrowing — it was controversial even during the emerging-market selloff sparked by the Federal Reserve’s 2013 taper tantrum — I guess the thinking was that if it worked then, it would work again.

 

Sure enough, borrowing overseas — and raising foreign-currency deposits from the diaspora — might buy the rupee a breather. Analysts expect that the latest package will bring in $50 billion. Some of the funds may come in via the bond market, where foreigners have been given tax breaks and more freedom to invest. But the bulk may be brought home by local borrowers scooping up three- to five-year money overseas, provided that the RBI gives them a similar concession on hedging cost as in 2013: roughly 3 per cent a year. That’s the burden taxpayers will bear, via reduced central-bank dividends to the government.

 

However, the euphoria around short-term inflows won’t fix the core weakness in India’s external accounts. An economy that topped all forecasts and grew 7.8 per cent in the March quarter — when the Iran war had already begun — shouldn’t be struggling with just $3 billion in net annual foreign direct investment. Nor ought it to be fighting so hard to bring back financial investors who have taken out $35 billion from the stock market over the past 12 months. Telling them that any individual can park money with an Indian portfolio manager isn’t of much use when they can as easily enter via a foreign fund. The problem is, they don’t want to. Not right now. 

 

A part of the pessimism has to do with paucity of imagination. Beyond building power-guzzling data centers, India lacks a compelling story for global capital hunting for AI innovation. While that isn’t something a central bank can do much about, it can at least give savers more remunerative interest rates. What’s the point of near-8 per cent growth in gross domestic product that doesn’t reward households financing the expansion, forcing them to chase risky returns outside of bank deposits?

 

It might have been acceptable if frothy stock prices were leading to new jobs or wage increases. But that isn’t the case, either. The net result of India’s supposed pro-growth policies is that they’re keeping valuations high — so that foreign firms and private equity investors in startups can get profitable exits. Instead of being just another gauge for the economy, the market has become its proxy. 

 

As part of the 2013 currency rescue, India raised benchmark interest rates to 8 per cent. The then-RBI Governor Raghuram Rajan had to leave them there for a year, even though the overnight US rate was near zero throughout. He was roundly criticised for keeping a tight lid on liquidity.

 

That playbook, which helped the central bank re-establish its inflation-fighting credibility, isn’t getting enough attention. Sanjay Malhotra, the current RBI chief, is sticking with borrowing costs that have fallen by 125 basis points since he took over in December 2024. On Friday, the monetary policy committee decided to stay pat at 5.25 per cent. That’s too small a premium for investors when the Fed’s target range is 3.5 per cent to 3.75 per cent, and expectations are growing that its next move will be a hike. 

 

It’s very clear what authorities are trying to do here — stabilise the currency, keep domestic rates low, and avoid capital controls. Juggling with the three objectives requires putting taxpayers on the hook, which is what an expected 3 per cent concession on dollar borrowers’ hedging cost effectively means. But ultimately, if capital controls are to be avoided, and the rupee is to be saved, then there’s no real choice. The only path to lasting peace on India’s external accounts goes through higher rates.

  (Disclaimer: This is a Bloomberg Opinion piece, and these are the personal opinions of the writer. They do not reflect the views of www.business-standard.com or the Business Standard newspaper)