Rupee slides too fast and steep

The panic triggered by the decision of the Reserve Bank of India (RBI) to curb capital outflows has further put pressure on the already weakened rupee (INR) that touched an all-time low of 62.03 against dollar in intra-day trade on Friday.

The RBI, on the eve of India’s 67th Independence Day, announced curbs on Overseas Direct Investments (ODI), reducing from 400 percent of net worth to 100 percent of net worth, through the automatic route. The central bank is effectively curtailing Indians from investing abroad and has gone one step further to ban the purchase of property abroad.  The import of gold in the form of coins and medallions has been banned by the government.

This cap on ODI limit, however, does not apply to ODI by Navratna PSUs, ONGC Videsh Ltd and Oil India in overseas unincorporated entities and incorporated entities, in the oil sector.
The move on capital controls by the RBI is by far the most damaging for the INR.  Though the capital controls are confined to the resident Indians, it has left the foreign investors worried as they fear some form of controls on their investments in the days to come.
The RBI should have realised that capital controls are a retrograde step which take us back to pre-1991 era of closed economy.  The world is replete with countries that have failed to prevent currency depreciation through capital controls. Malaysia in the late 1990s, Argentina in the 2000s and Iceland imposed capital controls post its crisis in 2008 are examples of capital controls that never worked.
The decision to curb capital outflows is a pre-1991 era solution to a problem in the post-liberalised era. Curb on capital movement was the bulwark of the country’s economic policies during the pre-liberalised era when it very frequently faced balance of payment crisis.

Panic-driven move

Efficacy of the move to curb capital outflows looks unnecessary and panic-driven given the outflows have already been declining this year. Instead, traders fear the capital restrictions could adversely impact company profits and could lead to stronger capital restrictions that would scare off foreign investors. The measures to restrict capital outflows come as overseas investments from India had already been on the wane, averaging a monthly $400 million in the first half of the year from $710 million in 2012.
The central bank should have realised the simple fact that the money will not come in if it is not allowed to move out.

What the curbs mean?

If this curbs on capital outflow had been in place a decade back, the Tatas would have thought thrice about buying Corus or Jaguar Land Rover, the Birlas would have found it tough to buy Novelis and Bharti Airtel may not have dared to buy Zain.
In short, Indian companies that want to invest abroad cannot do so easily now without going through the bureaucratic hassles. While the public sector oil companies, already enfeebled by having to dole out subsidies, are allowed to do what they find difficult.

Impact

The RBI move has affected the confidence among the participants in the market and has raised questions about the country’s financial fundamentals at a time when the country’s GDP is revised to lower levels and the current account deficit is widening.
The foreign investors are worried that more capital controls could be introduced to limit the movement of their capital.
NRIs are worried about their ability to move in and out of Indian bank deposits. They are discouraged to deposit any money in their home country for the fear of curbs on its movement.
If the Indian companies do not want to invest in the country and cannot invest abroad, they would not like to take risks and would want to wait till the crisis blows over.

Assuring words

Realising the negative impact of the RBI move on the markets, the Finance Minister P Chidambaram sought to clarify that these measures should not be viewed as retrograde. However, the damage has already been done and it takes herculean efforts on the government and the RBI to restore confidence and to stop rupee volatility.

(Published in Oped in City Today on August 17, 2013)