RBI curbs bond flows in bid to 'bulletproof' rupee

Mumbai

CENTRAL bank governor Raghuram Rajan is curbing access to India's bond market as inflows make the rupee Asia's best performer during a global currency war.

The Reserve Bank of India (RBI) hasn't allowed fresh overseas investment in government bonds since it raised the ceiling to US$30 billion in 2013. Mr Rajan said on Feb 3 that foreign investors can only buy corporate notes maturing in at least three years. Foreign investors have already filled the sovereign debt quota, which aims to prevent hot money from destabilising the market.

The rupee has climbed 1.5 per cent against the dollar this year as global funds pumped US$4.5 billion into Asia's highest yielding investment-grade debt. Mr Rajan said that India risks "becoming uncompetitive" as the rest of the world prints money and it needs to have a "bulletproof balance sheet" when US interest rate increases trigger outflows.

"The central bank doesn't want to open the doors wide to volatile capital flows that will temporarily appreciate the currency and then push it lower once the Federal Reserve starts raising rates," Dariusz Kowalczyk, a strategist at Credit Agricole CIB in Hong Kong, said on Feb 12. "India needs a weaker exchange rate to be competitive."

The rupee has this year strengthened against 30 of 31 major currencies as central banks from Canada to Australia sought depreciation to fight disinflation. The euro fell to an 11-year low versus the dollar after the European Central Bank expanded asset purchases. Singapore's dollar reached its lowest level since 2010 after the authorities sought slower appreciation.

On a trade-weighted basis, and after adjusting for inflation, the rupee was 24 per cent overvalued against currencies of India's six largest trade partners as at Feb 10, and by 11.5 per cent versus a basket of 36 exchange rates, according to a gauge compiled by the Reserve Bank .

"The RBI will be concerned about relative rupee strength against its trading partners as global central banks look to keep their currencies on a weak footing," Radhika Rao, an economist with DBS Bank Ltd in Singapore, said on Feb 12. "It wouldn't want hot money inflows to excessively strengthen the currency."

Slower inflation and faster growth in Asia's third-largest economy have burnished the appeal of the highest-yielding debt among the region's major economies. India's benchmark 10-year sovereign notes pay 565 basis points more than similar-maturity US Treasuries, data compiled by Bloomberg show.

The yield on the bonds due July 2024 rose one basis point, or 0.01 percentage point, to 7.71 per cent as at 10.26am in Mumbai on Monday. The rupee rose 0.1 per cent to 62.1525 a dollar. While the median forecast in a Bloomberg News survey is for a drop to 63 by June 30, Royal Bank of Scotland Group plc predicts an appreciation to 61 as an improving economy attracts inflows.

Gross domestic product will expand 7.4 per cent in the year through March 31, the Statistics Ministry estimated last week, on a par with China's growth. The 7.5 per cent pace reported for the third quarter under a revised method of calculating GDP is the fastest among large emerging markets. Consumer prices rose 5.11 per cent in January from a year earlier, below the central bank's 6 per cent inflation target for January 2016.

"The appreciation bias for the rupee will continue on the back of improving current account and overall growth," Gaurav Kapur, senior economist at RBS in Mumbai, said on Feb 12. "Stronger capital inflows would allow RBI to build foreign exchange reserves to deal with global market disruptions such as normalisation of rates by the US Fed and buttress external stability."

India's foreign reserves rose to a record of US$330.2 billion as at Feb 6, according to central bank data. Morgan Stanley predicts the current account, the broadest measure of trade, will swing to a surplus of US$1.5 billion in the year starting April 1, spurred by the drop in crude oil prices and gold-import curbs.

The Reserve Bank kept its benchmark repurchase rate unchanged at 7.75 per cent on Feb 3 after reducing it by 25 basis points in an unscheduled move on Jan 15.

"We are in the midst of the age of competitive depreciation and 'beggar thy neighbour' monetary policy," deputy governor Urjit Patel said in Mumbai on Feb 3. "This forms an important backdrop of our macroeconomic management as we go forward and face these quite unusual challenges." BLOOMBERG