By Shamik Paul and Manoj Kumar
MUMBAI/NEW DELHI (Reuters) - India stepped up its defence of the ailing rupee on Wednesday, proposing to relax overseas borrowing rules and curb some imports in order to ease a huge current account gap, while the RBI re-emphasised its commitment to stabilising the currency as it neared a record low.
The tag-team approach, including RBI interventions in the foreign exchange market, helped the rupee rally, a day after losing 1.8 percent as remarks by Reserve Bank of India Governor Duvvuri Subbarao led traders to question its ardour to defend the currency.
The RBI has implemented a series of steps to tighten market liquidity and raise short term interest rates in order to shore up the rupee. On Tuesday, traders were rattled after Subbarao said the central bank would return to a pro-growth monetary stance only once the currency stabilised.
"We have said that we will continue and we will persist with the liquidity tightening measures until the Reserve Bank has come to a determination that volatility in the exchange rate has been controlled," Subbarao said on a conference call on Wednesday.
"That continues to be our resolve and that is the way we are going to go forward," he said.
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Separately, Finance Minister P. Chidambaram said the government was looking into liberalising foreign direct investment rules, attracting funds from non-resident Indians and clamping down on the import of non-essential items such as electronics.
"There's no rocket science in manufacturing basic electronic hardware ... So we can manufacture electronic hardware goods here," he told a news conference in New Delhi.
He did not give specifics, but analysts have said that would be achieved through higher duties.
The rupee rose to a session high of 60.77 per dollar after Chidambaram's afternoon comments, pulling back from a low of 61.17 earlier in the day.
It hit an all-time low of 61.21 to the dollar on July 8, and has lost nearly 10 percent this year.
Intervention also helped prop up the currency, with traders saying RBI sold dollars twice during the day.
CURRENT ACCOUNT WOES
India is saddled with a current account deficit that hit a record 4.8 percent of gross domestic product (GDP) in the fiscal year that ended in March.
That makes the rupee especially vulnerable as foreign investors retreat from emerging markets on expectations that the U.S. Federal Reserve will soon begin winding down its ultra-loose monetary policy.
The Fed likely will decide at the end of a policy meeting on Wednesday to continue buying bonds, but it could raise the possibility of scaling back purchases later this year without clarifying whether that process will begin in September, as markets expect, or later.
Such a move could fuel further gains for the dollar as the world's largest economy picks up, and fresh downward pressure on emerging market currencies.
"The statements from the finance minister and governor cannot work in isolation. It will work if the global currency movements also work in favour of the rupee," said Abhishek Goenka, chief executive at India Forex Advisors.
"Having said that, I think the selling in the rupee is overdone and we may see a correction to 58 levels in the next two months," he said.
Analysts say the RBI will have to either raise policy interest rates - risking even slower economic growth - or squeeze rupee liquidity further to stop the rot. But even that would only buy time as India's external deficit erodes the currency's value.
Subbarao, whose five-year tenure is due to end in early September, acknowledged on Wednesday that it will take time for measures to narrow the current account gap to take effect.
"Both the Reserve Bank and the government will try to see how to adjust the current account deficit," he said.
"Adjustment in the current account inevitably by its very nature takes time. But sending out the right signal that we are making an effort to adjust, itself will make financing current account deficit easier," he said.
Ultimately, responsibility lies with Prime Minister Manmohan Singh's weak coalition government to introduce credible measures to trim the current account gap to the 2.5 percent level that the central bank regards as sustainable - a task made more challenging with elections due by next May.
Earlier, Trade Minister Anand Sharma said the government would increase interest subsidies for some export goods.
The RBI's rupee defence measures this month have squeezed corporate borrowers and prompted economists to lower their growth forecasts for Asia's third-largest economy, which grew at just 5 percent in the last fiscal year, its weakest in a decade.
India's government stepped up planned spending by different ministries such as rural development, roads, railways, health and education by nearly 30 percent in the first four months of the fiscal year, probably to boost economic growth in the absence of private investment, data on Wednesday showed.
(Writing by Tony Munroe; Reporting by Rafael Nam, Subhadip Sircar, Swati Bhat, Suvashree Dey Choudhury and Archana Narayanan; Editing by Kim Coghill)