Will the recent measures announced by the RBI hurt dollar inflows?

ISSUE

K Harihar
Head Integrated Treasury, DCB

On April 17, the Reserve Bank of India (RBI) announced a major rationalisation of interest rates offered to non-resident Indians on rupee-denominated deposits.

It announced that the interest rates on non-resident external (NRE) rupee deposits for one to three years, contracted effective close of business on April 17 should not exceed the Libor/ swap rates for US dollar of corresponding maturity.

The interest rates as determined above for three year deposits would also be applicable in case the maturity period exceeds three years. The changes in interest rates will also be applicable to NRE deposits renewed after their present maturity period. To be fair, this was not a bolt from the blue and the market had been anticipating some such measure for a while.

The big question is will this move hurt inflows? It really would not have a material impact as far as non-resident deposits are concerned.

It must be realised that a substantial part of inflows is really deposits in retail amounts coming to families of non-residents working abroad. This is money coming back home and not hot money looking for extraordinary profits.

Recent data suggest that remittances sent home by Indians residing abroad exceeded $8 billion in 2003 and apparently India was the second largest recipient of inward worker remittances after Mexico.

This has been maintained through the period of interest rate cuts unleashed by India over the last many months bearing out the theory that these remittances would be inelastic in behaviour to interest rates.

Further not all of it would stay as deposits and may get invested in the capital market, the money market and the property market where the returns would be higher.

But the official policy has been consistent and clear that we would not, as a country, like to invite arbitrage between US interest rates and rupee interest rates since it clearly leads to swings in an increasingly choppy global interest rate situation.

It must also be noticed that India is not unique in this regard and even other Asian countries such as Pakistan have been receiving huge remittances even though their local interest rates are very low.

From a asset liability management point of view of a country also, this is a very sensible move as we should not be seen to actively encourage inflows of money into short-term deposits, which is where most of the NRI deposits go in.

While the deposits have remained steady, theoretically, they are repatriable and we would not want substantial accumulation of short-term money. Also, if it is inelastic to price then it is all the more necessary to reduce the price.

As a country our reserves would get impacted not just by the undeniably significant NRI inflows, but also by other factors. The stock markets, by popular consensus, are expecting a total inflow of around $10 billion.

This would have more definitiveness if the new government keeps up the tempo of reforms.Further, there is talk of larger and ambitious divestments next year which could entice foreign funds.

And with a more relaxed policy stance on external commercial borrowings, large inflows are ahead. These will definitely offset any reduction in NRI inflows, if at all there is any.

Caught in a vicious circle

Moses Harding
Executive VP, IndusInd Bank

The measures announced by the Reserve Bank of India (RBI) comes as no surprise to market participants.

In fact, more stringent measures were being debated - a possible repo cut or aggressive forward dollar purchases by the RBI to bridge the huge interest differential and thereby scuttle arbitrage.

But are the moves good enough? Not long ago, the NRE rate was brought under regulation - which was reduced from Libor + 2.50% to current levels, with little impact on the exchange rate.

The move is, no doubt, to bridge the huge gap between demand and supply "" the RBI stepped in to prevent runaway rupee appreciation.

The rupee continues to remain strong and RBI has no option but to keep a continuous check to prevent a sharp rise - not an enviable position indeed.

Does this trend of rupee appreciation warrant these measures? I believe not.

It has done more good than harm for the overall economy to keep 'India Shining' theme intact.

It has helped to pursue a soft and declining interest rate regime (the benefit of this is felt across the economy) bringing back buoyancy to the stock market.

It has helped in reducing the oil bill guiding the inflation to sub 4.5%. The Indian corporate making the best out of this situation - huge reduction in interest cost, thus an improved performance and an increase in flow of money to the exchequer.

The only loser seems to be small and medium enterprises that are caught unawares "" they do not have the skill to manage volatility and get maximum benefit from the reduction in interest rates.

Is it the duty of the RBI and the government to protect the SME segment that provides employment in the rural and semi-urban areas? Indeed, yes. It is also a concern for powers-that-be that all these measures are not bringing in desired results.

The need of the hour for the RBI is to stop the supplies coming in for arbitrage reasons. There are two ways to do this - bring down the repo rate or guide the forward premiums to above 2.5 per cent, annualised.

There are no signs of a reversal in the rupee's appreciating trend "" unless we see a rise in US interest rates (which is unlikely till the end of 2004).

The Indian economic growth will continue to attract foreign money- which is welcome - especially into the core sectors.

It also makes sense for corporates to remain unhedged on imports and stay fully hedged on exports.

I doubt if even reduced dollar supplies from arbitrage will help to reverse the trend. This means no amount of RBI measures would help the market get out of this vicious circle - only a steady move to capital account convertibility will help matters.

Only a reversal in global interest rates will guide investment flows out of India.

Until then, the huge mismatch in demand and supply is here to stay.

Hence, eyes will be focussed on the Federal Reserve and its open market committee meeting due in early May 2004. The signals emanating from there should help the RBI bring matters under control.