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Rupee bulls hear a message from Reddy
Tuesday, 18 January , 2005, 17:39

Bombay: Just by theoretically mentioning the possibility of capping investment flows, RBI's chief has ignited speculation the central bank is eager to guide the rupee lower. Reserve Bank of India governor Y.V. Reddy courted controversy when, speaking at a book launch last week, he spoke of limiting foreign institutional investments.

"He wants to play down the optimism about the local currency," said Dhananjay Sinha, economist at ICICI Bank. "Reddy wants to guard against financial market instability."

The central banker spoke only of options and he even pointed out that limiting flows now was not a good idea right now.

"While quotas and ceilings may not be desirable at this stage, there is merit in our keeping such an option open," Reddy said, adding any curbs would only be exercised selectively.

The comment immediately triggered a rebuttal from the finance minister. But analysts said the message had been sent.

"We feel the central bank will eventually guide the rupee weaker," said Sanjeev Sanyal, senior economist at Deutsche Bank in Singapore.

The rupee which is partially convertible, rose nearly 5 percent in 2004 on the back of a record $8.5 billion of foreign fund inflows. It appreciated 5.2 percent in 2003.

Sanyal said he expected the rupee to ease towards 45 per dollar over the next 12 months, from 43.70 currently.

He said the central bank appears to be worried about foreign money driving the rupee too high and making an already bloated trade deficit even worse.

The stronger rupee has boosted imports and widened the country's trade deficit to $20.15 billion in the April-December period, up 42 percent from a year earlier. The nation's current account slipped into a deficit for the first time in more than a year during the July-September quarter.


Reddy already has a reputation as a verbal interventionist.

Seven and a half years ago, when he was a deputy governor in charge of monetary policy, Reddy sparked a sharp downward correction in the rupee when he said it was overvalued.

While India limits foreign inflows into government and corporate debt at $2.25 billion a year, there is no ceiling on investments in shares.

The central bank intervenes through state-run banks, which have about 60 percent share of the $9 billion-a-day forex market. Its purchases of dollars to check the rupee's rise have swelled reserves to $129 billion, from $103 billion a year earlier.

The rupee is convertible on the current account, but there are restrictions on capital flows mainly on doubts about the health of the country's financial system and a stubbornly high fiscal deficit of nearly 5 percent of gross domestic product.


Reddy's remark affected more than the currency market.

Foreign funds were already taking profits after the Bombay benchmark index <.BSESN> hit a life high on Jan. 4, and the suggestion of an investment cap only served to deepen the slide.

"Reddy's comments were ill-timed as the local equity market has been undergoing a correction owing to foreign selling, after a strong run in the last several months," Rajeev Malik, economist with JP Morgan Chase in Singapore, said in a note.

Finance Minister P. Chidambaram moved quickly to rule out any plan to curb foreign inflows into stocks.

The Congress-led government has been trying to shed its leftist image by wooing foreigners to help lift economic growth to 8 percent a year from the current 6 percent.

Reddy's predecessor at the central bank, Bimal Jalan, said any controversy had already dissipated. "In hindsight, the timing may have been misplaced. But it seems like it is all over and that is good for the economy."

Hours before Reddy's speech, India scrapped a restrictive rule which required foreign firms to seek permission from local joint venture partners to set up a related enterprise.

The rule was a hurdle for foreign direct investment (FDI) in Asia's fourth-largest economy. India aims to boost FDI to about $10 billion a year from $3-4 billion a year. That would still be far behind the $60.6 billion China attracted in 2004.
Copyright 2004 Reuters Limited. Click for Restrictions

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