Rupee weakens 13% YTD: Here are possible measures policymakers can take to stem depreciation

ICICI Securities

In a balance of payment induced sell-off, currencies usually always overshoot the fair value and the rupee has seen a significant depreciation of late and has breached the 72 mark against the US dollar.

India’s macro fundamentals are robust as is evidenced by the recent strong GDP growth rate report and the benign inflation trajectory. Our FX reserves are also substantial at around $400 billion and we have adequate buffers to cater to external payment obligations. Even when compared with the other EMs who are now under significant strain, our external funding metrics look far more stable. It also seems that the government is also actively considering a combination of measures which are likely to be announced soon.

As such, an optimal combination of intervention and policy interest rate action should be adequate for containing significant volatility. However, for the sake of being through we also review the spectrum of unconventional measures available to policymakers.

What are the possible measures policymakers can take to stem depreciation?

We first note that given the degree of overvaluation that the rupee still faces against its peers, from a competitiveness perspective the benefits of depreciation is undisputed. However, too much volatility and correction over a short period of time may be counterproductive and hence it is possible that some measures could be considered as had been done in 2013.

Immediate and short-term measures:

Aggressive intervention using all tools: We believe that the most effective immediate defence of the currency is through the central bank’s/government’s verbal and actual dollar intervention. India currently has around nine months' import cover and still has an outstanding forward book of around $10 billion as of July 2018.

Interest rate hikes: In the entire toolkit available to the central bank an intervening action also cannot be ruled out. We had originally expected the MPC to pause in October as the inflation trajectory currently looks fairly benign. However, if the pressure on the currency were to continue, then October hike of 25-50 bps is certainly on the cards and we feel that it is time that the MPC also changes its stance from “neutral” to “withdrawal of accommodation”.

Bolstering dollar swap lines with foreign central banks: India would have to strengthen swap lines with other developed market central banks to help bolster availability to funds during the time of a transitory crisis.

Special swap window for oil importing companies: Oil importers constitute a very strong and continuous source of natural dollar buying, which can be temporarily withdrawn from the market to improve the demand-supply dynamic to an extent.

Mobilising dollar funds by targeting NRIs: The FCNR(B) subsidised swap scheme in 2013 was the most effective policy measure and India garnered total flows of around $34 billion through deposits and banking capital channel.

Medium-term measures to address depreciation via reducing the Current Account Deficit:

In major pressure points for our import bill, electronics imports have risen from around $32 billion to $53 billion over FY14-FY18. Over the same period, ores and minerals, machinery and base metals have also risen by around $6-7 billion. Sharp increase in jewellery imports in FY18 was also a pressure point but that trend has come down sharply now.

For example, in April 2015, the government had raised import tariff value of gold to $388 per 10g from $375 per 10g, which was effective in curbing gold imports. Also, the government increased duty on crude palm oil from 33 percent to 48.4 percent in March and the duty on soft oils was also increased to 38.5 percent in June 2018. However, these measures take time to have an impact.

In this context, the ‘Make in India’ programme, which aims at making India a global hub for manufacturing and an integral part of the global supply chain, is a key step to reduce reliance on non-core imports.

The government has identified 10 ‘champions sectors’ that have potential to drive double-digit growth in manufacturing, including Capital goods, Auto and Auto Components, Defence & Aerospace, Biotechnology, Pharmaceuticals and Medical Devices, Chemicals, Electronic System Design & Manufacturing (ESDM), Leather & Footwear, Textiles & Apparels, Food Processing, Gems & Jewellery, New & Renewable Energy, Construction, Shipping and Railways.

Further, a policy on preference to domestically manufactured select iron and steel products has been enforced since May 2017. As an example of what could be done, there is a scope for ship-building industry that can be unlocked, which will not only create a strong manufacturing base but also generate millions of jobs.