Will ECB restrictions help save the rupee?

DEBATE

Opinion remains divided on how important ECB flows are in comparison with FDI/FII flows and, therefore, on how effective the measure will be?

Sanjay Bhatia,
Managing Director,
Hindustan Tin Plate

Net ECBs were around 36 per cent of net inflows in 2006-07 "" so the impact of the ECB curbs will be large

To gauge the impact of restrictions imposed on ECBs, one should know the share of it in the overall capital flows into the country. There are two ways of looking into it; one by measuring the percentage share of the ECBs in the gross capital flows and the other in the net flows. For fiscal 2006-07, gross capital flows were $227.4 billion and ECBs were around $21.2 billion, or roughly 9 per cent. Net inflows, during the same period were $44.9 billion of which net ECB flows were $16.1 billion, after deducting repayments of $4.2 billion "" the proportion of net ECBs to the net capital flows is 36 per cent. On both counts, the share of ECBs to the total capital flow is significant.

Therefore, the restrictions imposed by the RBI will have a significant impact on capital flows and will result in the consequent easing of the rupee that, in turn, will augment export competitiveness.

There are already restrictions imposed on the inflow of ECBs based on end-use, such as funds' flow to real estate and other speculative activities. A quick analysis made by the PHD Chamber reveals that corporations that were depending heavily on ECB route for interest rate arbitrage are now looking at raising capital domestically. There is enough liquidity in the domestic market. Hence, the apprehension that it may fuel further increase in the interest rate is misplaced.

Some of the corporations, which had availed ECBs in the past have been taking advantage of the rupee hardening to pre-pay their debts. I feel the corporations should continue to do so. This would help in two ways. One, by liquidating the debt, they also help the government to stem the pace of rupee appreciation. Two, it will help reduce the overall debt exposure.

The RBI restrictions are temporary in nature. Central banks the world over modulate currency flows. This is true even of nations having full capital account convertibility. Those interventions are referred to as course corrections. It is a fact that, of late, capital flows through the ECB route have gone up significantly "" it is estimated that ECB inflows in the last six months were around $16 billion, which is obviously on the higher side. The regulator had to take cognisance of this trend and apply corrections.

Because of the excess capital inflow, the RBI had to resort to putting into circulation matching rupees to stabilise the exchange rate. This, in turn, fuelled inflationary pressures. Moreover, the RBI's intention is not to dry a source which has helped corporations to tide over their liquidity needs, both for working capital and further investment.

The author is President of PHDCCI

Bharat Banka,
Head (Corporate Finance),
Aditya Birla Group

FII inflows are up to $1bn a month. Since this is not being curbed, inflows will continue and rupee impact will be low

In May, in this very space, I had said the rupee would appreciate further and since then, it has moved towards the psychological mark of 40. In the medium to long term, that is, two-three years, I see no reason to change my view on appreciation beyond 40. Once the rupee stays below the psychological level of 40 for a few weeks, the market will reconcile to it. Given that the RBI's current priorities are inflation, liquidity management, interest rates, GDP growth and exchange rate, it was natural to expect the RBI to turn to liquidity management.

So, we get an increase in the CRR as a measure to control domestic liquidity and ECB restrictions to attempt to tighten forex inflows. The ECB part has been done deftly, ensuring the global acquisition spree by India Inc doesn't get derailed and ECB to fund imports are unrestricted. That is good news for a country that imports almost twice of what she exports, the balance of payment expected to be $40 billion-plus this fiscal. The fact that at $16 billion ECB inflows were less than 2 per cent of GDP in the last fiscal speaks volumes about the importance of ECBs. The only portion of ECB being impacted is the one being spent on the domestic part of projects, that is, equipments and materials sourced locally and construction costs.

With the turmoil in the sub-prime market, the quality and pricing of Indian credit would undergo a change, even if marginally. This would reduce the arbitrage between domestic borrowing and ECB, making Indian borrowers indifferent to where they borrow. This leads to the belief that the ECB curb appears a liquidity management measure rather than exchange rate management.

Look at flows from equity, GDR, ADR and FII flows. In July '07 itself, net FII equity buying was more than $4 billion and in Q1 FY08, the monthly average was $1 billion. In my view, this is a bigger contributor to the flows/ liquidity as compared to ECBs. Are we going to see any curbs on this side? Unlikely! Let us go through some of the soft hints dashed out by the finance minister in the last few months.

To exporters "" while a certain class of exporters could be provided relief due to the appreciating rupee, market forces would dominate and exporters should take steps to improve efficiency and be innovative. To foreign investors "" the policy on participatory notes is not being reviewed.

That is, the pro-equity investor stance will continue, contributing to the liquidity while the RBI would dabble with measures relating to the banks and debt portion of capital. Since the impact on flows will be marginal, the impact on currency will also be marginal. The overt concern of regulators on currency appreciation is to be expected but beneath the surface, regulators don't mind a stronger rupee "" after all, think of India's huge oil import bill!

The views are personal