RBI Tweaks ECB + Other Norms to Strengthen Rupee

Dear All,

The RBI has yesterday made some important announcements that could result in a strengthening of Indian rupee and prevent the present turmoil in the currency markets:

1. Reserve Bank of India (RBI) in an effort to support the falling INR has directed Indian companies to bring back offshore funds, raised through external commercial borrowings (ECBs) for the purpose of domestic business expenditure. Those funds need to be parked with Indian banks. This measure is likely hold rupee's depreciation to an extent since over the last few months it has being observed that some exporters and project finance companies seem to be holding back their money raised through ECB in anticipation of further rupee depreciation, however now they have to bring bank the raised ECB into the Indian Banking system.

Thus, as the Rupee-dollar movement is a function of demand-supply. This measure is likely to strengthen rupee against the dollar. Bringing back of money raised from abroad will create demand for rupee against the dollar, which in turn, will help the rupee to rise against the greenback.

2. RBI has hiked the ceiling of ECB rate. Companies can now borrow foreign funds at a higher rate at six month London Interbank Offered Rate (LIBOR) + 350 basis points compared to LIBOR + 300 basis points earlier, for an average maturity period of three to five years. For maturity period of more than five years, rates remain unchanged at 6 month LIBOR + 500 bps. The enhancement in ceiling will be applicable up to March 31, 2012.

The rate hike is aimed at encouraging companies to raise more funds through ECBs. Therefore bring back that money back home in India. In turn, it will prompt dollar selling against the rupee.

3. The Reserve Bank of India (RBI) also decided to remove the upper limit of US$100 million placed on Foreign Currency – INR swaps transactions that the Indian banks enter into as intermediaries for matching the requirement of their corporate clients.

This move will also result in swapping of more dollar exposure by the corporate and allow them to hedge their risk arising form the rising dollar.

Thus, it makes sense not to go with the market speculation and short INR, levels of 52.8 which is the life time high for USD-INR should be considered as a good support level for INR.

Regards,

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Rahul Sonthalia

Credit Policy Analysis

The Reserve Bank of India announced its third quarter review of monetary policy. The bank raised the Cash Reserve Ratio (CRR) by 75 bps to 5.75% and left the key policy rates, repo and reverse repo unchanged. The hike in CRR was above the street expectation of a 50 bps hike and the market reacted in a knee jerk manner, however has recovered because of a stronger growth outlook.

Some of the key highlights form the policy documents are:

· The Indian monetary authority sounded very bullish on growth in the third quarterly review of its annual monetary policy for FY10 and raised the growth projection for the economy to 7.5%, way ahead of its forecast of 6% with upside bias given in the last policy review three months ago

· The figure is also substantially higher compared with median forecast of 6.9% in the survey of professional forecasts release by the RBI on Thursday

· The deficient monsoon rainfall and drought conditions in several parts of the country have accentuated the pressure on food prices, pushing up the overall inflation rate – both of the WPI and consumer price indices (CPIs)

· The central bank says that even though a baseline scenario is comforting a number of downside risks to growth and upside risks to inflation are there

o There is still uncertainty about the pace and shape of global recovery and it is too dependent on public spending and will unravel if governments around the world withdraw their fiscal stimuli prematurely

o Expectations of softening domestic inflation are contingent on food prices moderating. This, in turn, depends significantly on the performance of the monsoon which if remains inadequate could continue to intensify inflationary pressures

o As growth accelerates and the output gap closes, excess liquidity, if allowed to persist, may exacerbate inflation expectation

Analysis:

The two-phased CRR hike will soak Rs 36000 crore from the banking system, that was the only negative that the RBI policy document. The way the banking and the real estate sector stock recovered clearly highlights the fact that the market has really taken this policy in a positive way, however one should remain cautious as there was nothing positive in the document which fundamentally could lead to a rally like today.