What will save the Indian rupee? There’s an election next year so forget about the stuff that’s really needed — structural reforms to labour and tax laws, easing business regulations and scrapping inefficient subsidies. The quickest and most effective short-term option may be a dollar bond issued to the Indian diaspora overseas which could boost central bank coffers about $20 billion.
Ten-year Indian bond yields have fallen 30 basis points this year alone and many forecast the gains will extend further. It all depends on two things though — the Feb 28 budget of which great things are expected, and second, the March 19 central bank meeting. The latter potentially could see the RBI, arguably the world’s most hawkish central bank, finally turn dovish.
So India has not joined emerging central banks’ rate-cutting spree . After recent rate cuts in Brazil, South Korea, South Africa, Philippines and Colombia, and others signalling their worries over the state of economic growth, hawks are in short supply among the world’s increasingly dovish central banks. But the Reserve Bank of India is one.
Indian markets are rallying this week as they price in an interest rate cut at the Reserve Bank’s June 18 meeting. With the country still in shock after last week’s 5.3 percent first quarter GDP growth print, it is easy to understand the clamour for rate cuts. After all, first quarter growth just a year ago was 9.2 percent.
The Indian rupee’s plunge this week to record lows will have surprised no one. After all, the currency has been inching towards this for weeks, propelled by the government’s paralysis on vital reforms and tax wrangles with big foreign investors. These are leading to a drying up of FDI and accelerating the exodus from stock markets. Industrial production and exports have been falling. High oil prices have added a nasty twist to that cocktail. If the euro zone noise gets louder, a balance of payments crisis may loom. The rupee could fall further to 56 per dollar, most analysts predict.
Indian equities are among the best emerging markets performers this year, with the Mumbai market having posted its best January rise since 1994. That’s quite a reversal from last year’s 24 percent slump. The bet is faltering economic growth will force the central bank to cut interest rates from a crippling 8.5 percent. So, how safe is the rally?
China moved to ease policy this week via a reserve ratio cut for banks, effectively starting to reverse a tightening cycle that’s been in place since last January. Later the same day, Brazil’s central bank cut interest rates by 50 basis points for the third time in a row. Both countries are expected to continue easing policy as the global economic downturn bites. And last week Russia signalled that rate cuts could be on the way.
It’s been a pretty miserable 2011 for India and Tuesday’s collapse of the rupee to record lows beyond 52 per dollar will probably make things worse. Foreigners, facing a fast-falling currency, have pulled out $500 million from the stock market in just the last five trading sessions. That means net inflows this year are less than $300 million, raising concerns that India will have trouble financing its current account gap. The weaker currency also bodes ill for the country’s stubbornly high inflation.