To save rupee, RBI may go for direct funding of crude buys, bond issue.

MUMBAI: The Reserve Bank of India may be forced to announce some measures in the next few days or weeks to arrest the rupee's slide, which is likely to worsen as the threat of the US Federal Reserve tapering bond purchases has triggered a flight of dollars back to America.

Some of the steps may include the much-anticipated direct funding of crude oil purchase by IndianOil, floating NRI bonds, and reducing the overnight exposure of banks to curb speculation, said people familiar with RBI's thinking.

Indeed, if interest rates in the US, which have risen by more than 100 basis points in past two months, continue to advance due to the strengthening economy, India may have to follow the example of Indonesia - which also runs a current account deficit - and raise interest rates.

The extent of pressure on the rupee became clear when one month non-deliverable forwards (NDF) rose to Rs 61.35 on Friday afternoon in a market battling reduced liquidity, said a trader. NDF is a cash-settled, short-term forward contract where trades happen overseas.

"We are in a situation where RBI could be looking at a few immediate steps," said Arvind Narayanan, executive director and head (sales, treasury & markets) at DBS India. "RBI could look at curbing discretionary non-trade payments overseas, or money retained outside may be ordered back into the country. RBI may also look at opening a special window from where oil companies could buy dollars, so that it does not disrupt the over-the-counter forex market."

The rupee is the worst-performing Asian currency as foreign funds pulled out $5.4 billion from Indian debt in June.

Foreign funds also sold Indian debt worth more than Rs 4,000 crore this month, data from the regulator shows. On Friday, the rupee closed at 60.24 to the US dollar.

The government and the central bank have been trying to curb demand for gold, one of the main causes of aggravating external deficit, by imposing stringent cash conditions on importing the metal and also raising the import duty on it. But the pressure on the rupee continues because global investors, who were borrowing at zero interest rates in the US to invest here, are now selling assets in anticipation of higher borrowing costs in America. On Friday, US treasury yields jumped to 2.73%, their highest since August 2011.

Topping the list of dollar consumers are oil companies, which require an average of $300 million a day. And the demand for dollars will only accelerate with nearly $172 billion of loan repayments coming up in the next one year. With the current account deficit at 4.8% of the gross domestic product and real interest rates remaining negative compared with the consumer price rise, the central bank may have to raise interest rates to attract flows.

"To stem the rupee's fall, we may even need to raise short-term interest rates," said Srinivas Varadarajan of Mount Nathan Advisors, which advises hedge funds. "When rates are raised during times of outflows, foreign investors appreciate it as the right measure."

Capital flows into emerging markets such as India may be reversing given that the US may start slowing $85 billion of monthly bond purchases. The fear of an imminent slowing has triggered a selloff in emerging markets.

Source : economictimes.indiatimes.com